Question 1

Explain how it is possible for the government debt to grow forever.

Accepted Answer

The debt can grow because the economy grows. If, for example, nominal GDP grows at 3 percent per year, and the debt also grows at 3 percent per year, then the debt will be a constant fraction of GDP. This is perfectly sustainable. Problems arise only if the debt grows faster than GDP. Such a situation cannot prevail forever, because that would imply that the debt would eventually be many times larger than GDP, and the government would no longer be able to pay the interest payments on its debt.

Question 2

Identify three of the five costs of inflation.

Accepted Answer

There are several costs of inflation, including the following: shoeleather costs, because people spend resources to economize on their holdings of money; menu costs created by having to change prices; increased relative price variability, which distorts signals provided by relative price changes; distortions in the tax laws that discourage saving; arbitrary redistribution of wealth from unexpected inflation; and the general inconvenience created by the lack of a fixed unit of account.

Question 3

In essence, a consumption tax puts all saving into tax-advantaged savings accounts.

Accepted Answer

A) True 
 B)False  True

Question 4

Suppose that the central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate supply shifts right, what should the central bank do, and what will happen to output?

Accepted Answer

A) The central bank should increase the money supply, which causes output to move closer to its long-run equilibrium. 
B) The central bank should increase the money supply, which causes output to move farther from its long-run equilibrium. 
C) The central bank should decrease the money supply, which causes output to move closer to its long-run equilibrium. 
D) The central bank should decrease the money supply, which causes output to move farther from its long-run equilibrium. 
A) The central bank should increase the money supply, which causes output to move closer to its long-run equilibrium. 
B) The central bank should increase the money supply, which causes output to move farther from its long-run equilibrium. 
C) The central bank should decrease the money supply, which causes output to move closer to its long-run equilibrium. 
D) The central bank should decrease the money supply, which causes output to move farther from its long-run equilibrium.

Question 5

Some social programs transfer wealth from younger generations to older generations.

Accepted Answer

A) True 
 B)False

Question 6

What is the relationship between deficit and debt?

Accepted Answer

A) Deficits require people to consume at the expense of their children. 
B) If the government uses funds to pay for useful programs, on net the debt need not burden future generations. 
C) If the government runs a deficit, it is necessarily in debt. 
D) High deficit implies high debt. n. 
A) Deficits require people to consume at the expense of their children. 
B) If the government uses funds to pay for useful programs, on net the debt need not burden future generations. 
C) If the government runs a deficit, it is necessarily in debt. 
D) High deficit implies high debt. n.

Question 7

Suppose that a country has an inflation rate of about 3 percent per year and a real growth rate of about 6 percent per year. Suppose also that it has nominal GDP of about 100 billion units of currency. What is the highest deficit it can have without raising the debt-to-income ratio?

Accepted Answer

A) just under 1 billion units 
B) just under 3 billion units 
C) just under 6 billion units 
D) just under 9 billion units 
A) just under 1 billion units 
B) just under 3 billion units 
C) just under 6 billion units 
D) just under 9 billion units

Question 8

Suppose the budget deficit is rising 2 percent per year and nominal GDP is rising 7 percent per year. Which of the following best describes the debt created by these continuing deficits?

Accepted Answer

A) sustainable, but the future burden on your children cannot be offset 
B) not sustainable, and the future burden on your children cannot be offset 
C) not sustainable, but the future burden on your children can be offset if you save for them 
D) sustainable, and the future burden on your children can be offset if you save for them 
A) sustainable, but the future burden on your children cannot be offset 
B) not sustainable, and the future burden on your children cannot be offset 
C) not sustainable, but the future burden on your children can be offset if you save for them 
D) sustainable, and the future burden on your children can be offset if you save for them

Question 9

Why should monetary policy be made by rule rather than discretion?

Accepted Answer

A) because the economy is subject to a variety of random shocks 
B) because monetary policymakers are now allowed undisciplined discretion 
C) because it is not clear how important political business cycles have been in the past 
D) because central banks can achieve credibility over time by backing up their words with deeds 
A) because the economy is subject to a variety of random shocks 
B) because monetary policymakers are now allowed undisciplined discretion 
C) because it is not clear how important political business cycles have been in the past 
D) because central banks can achieve credibility over time by backing up their words with deeds

Question 10

The cost of inflation reduction is less if people believe that the central bank will really reduce inflation.

Accepted Answer

A) True 
 B)False

Question 11

There are ways that policymakers could reduce the costs of inflation without reducing inflation.

Accepted Answer

A) True 
 B)False

Question 12

What is the principal reason that monetary policy has lags?

Accepted Answer

A) It takes a long time for changes in the interest rate to change aggregate demand. 
B) It takes a long time for changes in the money supply to change interest rates. 
C) It takes a long time for the Bank of Canada to make changes in policy. 
D) It takes a long time for the government to pass the necessary laws. 
A) It takes a long time for changes in the interest rate to change aggregate demand. 
B) It takes a long time for changes in the money supply to change interest rates. 
C) It takes a long time for the Bank of Canada to make changes in policy. 
D) It takes a long time for the government to pass the necessary laws.

Question 13

Why do many economists advocate a consumption tax rather than an income tax?

Accepted Answer

The current income tax means that income

Question 14

Consider the following rule for monetary policy: r = 2 percent + $\pi$ + 1/2(y - y*)/y* + 1/2($\pi$- $\pi$*), where r is the nominal interest rate, y is real GDP, y* is an estimate of the natural rate of output, $\pi$ is the inflation rate, and $\pi$* is the inflation target. What is the implication of this rule?

Accepted Answer

A) If aggregate demand shifts right from long-run equilibrium, this rule unambiguously implies that the Bank of Canada decreases the nominal interest rate. 
B) If aggregate supply shifts right from long-run equilibrium, we cannot tell without more information whether the Bank of Canada should increase or decrease the nominal interest rate. 
C) If output is at its natural level, but inflation is above its target, the Bank of Canada must decrease the nominal interest rate. 
D) If inflation is at its targeted level, but output is above its natural rate, the Bank of Canada must decrease the federal funds rate. 
A) If aggregate demand shifts right from long-run equilibrium, this rule unambiguously implies that the Bank of Canada decreases the nominal interest rate. 
B) If aggregate supply shifts right from long-run equilibrium, we cannot tell without more information whether the Bank of Canada should increase or decrease the nominal interest rate. 
C) If output is at its natural level, but inflation is above its target, the Bank of Canada must decrease the nominal interest rate. 
D) If inflation is at its targeted level, but output is above its natural rate, the Bank of Canada must decrease the federal funds rate.

Question 15

Identify three government policies that discourage saving.

Accepted Answer

First, the returns to saving are heavily

Question 16

To stimulate savings in retirement plans, suppose the capital gain is not taxed until it is realized (the money is effectively withdrawn from the account.) To simplify, suppose that when she is 70, our worker withdraws the entire amount in her account. How much will she receive if the capital gain tax is 40 percent?

Accepted Answer

If interest is not taxed until realized,

Question 17

Suppose people in countries that have had persistently high inflation are sceptical about efforts to reduce inflation. What will happen to the short-run Phillips curve and the sacrifice ratio?

Accepted Answer

A) The short-run Phillips curve remains to the left, and the sacrifice ratio will be low. 
B) The short-run Phillips curve remains to the left, and the sacrifice ratio will be high. 
C) The short-run Phillips curve remains to the right, and the sacrifice ratio will be low. 
D) The short-run Phillips curve remains to the right, and the sacrifice ratio will be high. 
A) The short-run Phillips curve remains to the left, and the sacrifice ratio will be low. 
B) The short-run Phillips curve remains to the left, and the sacrifice ratio will be high. 
C) The short-run Phillips curve remains to the right, and the sacrifice ratio will be low. 
D) The short-run Phillips curve remains to the right, and the sacrifice ratio will be high.

Question 18

Explain the time inconsistency of monetary policy.

Accepted Answer

Time inconsistency refers to the idea th

Question 19

Assume that the substitution effect is large relative to the income effect. If a tax reform is designed to increase saving, what does it do to the interest rate and spending on capital goods?

Accepted Answer

A) It increases the interest rate and decreases spending on capital goods. 
B) It increases the interest rate and increases spending on capital goods. 
C) It decreases the interest rate and increases spending on capital goods. 
D) It decreases the interest rate and decreases spending on capital goods. 
A) It increases the interest rate and decreases spending on capital goods. 
B) It increases the interest rate and increases spending on capital goods. 
C) It decreases the interest rate and increases spending on capital goods. 
D) It decreases the interest rate and decreases spending on capital goods.

Question 20

The cost of inflation reduction is a small but permanent increase in unemployment.

Accepted Answer

A) True 
 B)False

Explain how it is possible for the government debt to grow forever.

Identify three of the five costs of inflation.

In essence, a consumption tax puts all saving into tax-advantaged savings accounts.

Suppose that the central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate supply shifts right, what should the central bank do, and what will happen to output?

Some social programs transfer wealth from younger generations to older generations.

What is the relationship between deficit and debt?

Suppose that a country has an inflation rate of about 3 percent per year and a real growth rate of about 6 percent per year. Suppose also that it has nominal GDP of about 100 billion units of currency. What is the highest deficit it can have without raising the debt-to-income ratio?

Suppose the budget deficit is rising 2 percent per year and nominal GDP is rising 7 percent per year. Which of the following best describes the debt created by these continuing deficits?

Why should monetary policy be made by rule rather than discretion?

The cost of inflation reduction is less if people believe that the central bank will really reduce inflation.

There are ways that policymakers could reduce the costs of inflation without reducing inflation.

What is the principal reason that monetary policy has lags?

Why do many economists advocate a consumption tax rather than an income tax?

Identify three government policies that discourage saving.

Suppose people in countries that have had persistently high inflation are sceptical about efforts to reduce inflation. What will happen to the short-run Phillips curve and the sacrifice ratio?

Explain the time inconsistency of monetary policy.

Assume that the substitution effect is large relative to the income effect. If a tax reform is designed to increase saving, what does it do to the interest rate and spending on capital goods?

The cost of inflation reduction is a small but permanent increase in unemployment.

Ten Principles of Economics

Thinking Like an Economist

Interdependence and the Gains From Trade

The Market Forces of Supply and Demand

Measuring a Nations Income

Measuring the Cost of Living

Production and Growth

Saving, Investment, and the Financial System

Unemployment and Its Natural Rate

The Monetary System

Money Growth and Inflation

Open-Economy Macroeconomics: Basic Concepts

A Macroeconomic Theory of the Open Economy

Aggregate Demand and Aggregate Supply

The Influence of Monetary and Fiscal Policy on Aggregate Demand

The Short-Run Tradeoff Between Inflation and Unemployment

Filters

Exam 17: Five Debates Over Macroeconomic Policy

Explain how it is possible for the government debt to grow forever.

Identify three of the five costs of inflation.

In essence, a consumption tax puts all saving into tax-advantaged savings accounts.

Suppose that the central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate supply shifts right, what should the central bank do, and what will happen to output?

Some social programs transfer wealth from younger generations to older generations.

What is the relationship between deficit and debt?

Suppose that a country has an inflation rate of about 3 percent per year and a real growth rate of about 6 percent per year. Suppose also that it has nominal GDP of about 100 billion units of currency. What is the highest deficit it can have without raising the debt-to-income ratio?

Suppose the budget deficit is rising 2 percent per year and nominal GDP is rising 7 percent per year. Which of the following best describes the debt created by these continuing deficits?

Why should monetary policy be made by rule rather than discretion?

The cost of inflation reduction is less if people believe that the central bank will really reduce inflation.

There are ways that policymakers could reduce the costs of inflation without reducing inflation.

What is the principal reason that monetary policy has lags?

Why do many economists advocate a consumption tax rather than an income tax?

Identify three government policies that discourage saving.

Suppose people in countries that have had persistently high inflation are sceptical about efforts to reduce inflation. What will happen to the short-run Phillips curve and the sacrifice ratio?

Explain the time inconsistency of monetary policy.

Assume that the substitution effect is large relative to the income effect. If a tax reform is designed to increase saving, what does it do to the interest rate and spending on capital goods?

The cost of inflation reduction is a small but permanent increase in unemployment.

Ten Principles of Economics

Thinking Like an Economist

Interdependence and the Gains From Trade

The Market Forces of Supply and Demand

Measuring a Nations Income

Measuring the Cost of Living

Production and Growth

Saving, Investment, and the Financial System

Unemployment and Its Natural Rate

The Monetary System

Money Growth and Inflation

Open-Economy Macroeconomics: Basic Concepts

A Macroeconomic Theory of the Open Economy

Aggregate Demand and Aggregate Supply

The Influence of Monetary and Fiscal Policy on Aggregate Demand

The Short-Run Tradeoff Between Inflation and Unemployment

Filters