Exam 16: The Dynamics of Inflation and Unemployment

Recall Application 1, "Shifts in the Natural Rate of Unemployment" to answer the following questions: -According to the application, the Beveridge Curve depicts:

Assume everyone in an economy uses rational expectations. Now suppose that the Federal Reserve wants to reduce the inflation rate. Given the goals of the Fed, do you think the Fed should announce its policy to reduce the inflation rate? Explain.

When Bob receives a 5 percent nominal wage increase in a period where inflation is also 5 percent, then we say that he experiences no money illusion when:

After World War II, prices were increasing by 19,800% a month in Hungary. This is an example of a/an:

(a) What is the quantity equation? (b) If the velocity of money is constant and the economy is operating below capacity, what impact will an increase in the money supply have?

The heads of central banks are typically very conservative about inflation because:

According to the growth version of the quantity equation, if the money supply doubles while all else stays constant, then:

In an effort to improve the central bank's credibility in fighting inflation, the central bank in New Zealand:

INFLATION-INDEXED BONDS IN THE UNITED STATES Are there bonds that can protect your investments from inflation? In 1997, the U.S. Department of the Treasury created a new financial instrument called the Treasury Inflation-Protected Security, or TIPS. The key feature of TIPS is that the payments to investors adjust automatically to compensate for the actual changes in the Consumer Price Index. Therefore, TIPS provide protection to investors from inflation. Like other government bonds, TIPS make interest payments every six months and a payment of the original principal when the bond matures. However, unlike other Treasury bonds, these payments are automatically adjusted for changes in inflation. Despite their obvious attractions, the market for TIPS is still rather small. As of 2005, there were about $200 billion in TIPS outstanding, compared to a total volume of about $4 trillion ($4,000 billion) total Treasury obligations. Because TIPS compensate for actual inflation, the interest rate on these bonds differs from conventional bonds by the expected inflation rate. By comparing the interest rates on TIPS to other government bonds of similar maturity, economists can estimate the public’s expectations of inflation. SOURCE: Simon Kwan, "Inflation Expectations: How the Market Speaks," Federal Reserve Bank of San Francisco Economic Letter, October 7, 2005. -According to the application, the difference between the interest rates on TIPS and the interest rates on non- inflation indexed securities represents:

Suppose labor unions in most industries contemplate negotiating a large nominal wage increase that is expected to cause significant inflation. How will the credibility of the Fed in its fight against inflation affect their decision to pursue such wage increase?

The Phillips curve depicts the relationship between:

Explain how the following statements relate to the velocity of money. Assume a constant money supply. (a) Businesses around the country decide to pay workers only once a month in order to reduce paperwork and improve efficiency. (b) Banks around the country begin using a new check clearing system that allows checks to clear much faster than they did previously. (c) Credit card companies and banks announce a huge promotion to increase the use of credit cards for most, if not all, purchases. This includes food, utility bills, and most other necessities.

Recall Application 1, "Shifts in the Natural Rate of Unemployment" to answer the following questions: -According to the application, the observed Beveridge Curve relationship shifts when:

A decrease in inflationary expectations that causes a decrease in the growth rate of firms' prices shifts the:

In the long run, a decrease in the growth rate of the money supply will cause

Recall Application 2, "Increased Political Independence for the Bank of England Lowered Inflation Expectations," to answer the following questions: -According to the application, there is evidence that supports the conjecture that:

Suppose the public expects money supply and money demand to increase by 10 percent this year. If the Fed decided to allow money supply to increase by only 8 percent, explain what will happen to the real interest rates and investments in the short run.

If labor union leaders are successful in demanding a wage increase, then their actions will cause:

What role do expectations play in determining inflation? Explain.

If firms have rational expectations and if they set prices and wages on this basis, then: