Exam 18: Alternative Perspectives on Stabilization Policy

Economists who view the economy as naturally stable often argue that:

Assume that in a certain economy the LM curve is given by Y = 2,000r - 2,000 + 2(M/P) + u, where u is a shock that is equal to +200 half the time and -200 half the time, and the IS curve is given by Y = 8,000 - 2,000r. The price level (P) is fixed at 1.0. The natural rate of output is 4,000. The government wants to keep output as close as possible to 4,000 and does not care about anything else. Consider the following two policy rules: i. Set the money supply M equal to 1,000 and keep it there. ii. Manipulate M from day to day to keep the interest rate constant at 2 percent. a. Under rule i, what will $Y$ be when $u = + 200$ ? Under rule i, what will $Y$ be when $u = - 200$ ? b. Under rule ii, what will $Y$ be when $u = + 200$ ? Under rule ii, what will $Y$ be when $u = - 200$ ? c. Which rule will keep output closer to 4,000 ?

Advocates of passive policy argue that because monetary and fiscal policy lags are:

According to the Lucas critique, when economists evaluate alternative policies they must take into consideration:

Economic research finds that greater central-bank independence is ______ correlated with lower and more stable inflation as well as ______ correlated with the average growth and variability of real GDP.

Let the symbol $\pi$ stand for the rate of inflation, with E $\pi$ the expected inflation rate, both measured in percent. The letter u is the unemployment rate and uⁿ is the natural rate of unemployment. Suppose the short-run Phillips curve is u = uⁿ - $\alpha$ ( $\pi$ - E $\pi$ ) applies in a certain economy. The Fed's loss function is L(u, $\pi$ ) = u + $\gamma$ $\pi$ ². The analysis in the appendix to textbook Chapter 18 shows that if the Fed minimizes its loss function under the assumption that E $\pi$ is fixed and "rational" private agents know this, the expected inflation rate will be E $\pi$ = $\alpha$ /2 $\gamma$ , and this will also be the inflation rate the government chooses. a. Suppose that $\alpha = 0.5$ and $y = 0.05$ . What are the expected and actual inflation rates? b. Suppose $\alpha = 0.5$ and $y = 0.50$ . In this case, does the Fed have greater or lesser relative distaste for inflation than in part a? What are the expected and actual inflation rates with $\gamma =$ $0.50$ ? Why do they differ from the inflation rates in part a?

Economic science has provided convincing evidence in favor of the:

The lag between the time that economic stimulus is needed and the time that a tax cut is passed by Congress is an example of a:

If the Fed has discretion to choose its own policy and announces a policy of low inflation, then:

The outside lag is the time:

The time-inconsistency problem in discretionary policymaking about unemployment and inflation can be effectively avoided when the:

Keeping the money supply constant over the business cycle is an example of:

The Phillips curve describing an economy takes the form u = uⁿ - $\alpha$ ( $\pi$ - E $\pi$ ). The central bank directly sets the inflation rate to minimize the following loss function, L(u, $\pi$ ) = u + $\gamma$ $\pi$ ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, $\pi$ is the inflation rate, E $\pi$ is the expected inflation rate, and $\alpha$ and $\gamma$ are behavioral response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. Compared to making monetary policy with discretion, the optimal inflation rate will be ______ under a fixed rule and the unemployment rate will be ______.

Is the independence of the central bank of any country directly related to that country's economic growth?

Automatic stabilizers:

The concerns of economists who favor passive over active policy are most closely associated with their:

A policy rule:

A time-inconsistency problem in macroeconomic policy can occur when the policymaker:

Computer models of the economy:

The time between when government spending increases and when aggregate demand starts to increase is an example of an: