Deck 14: New Keynesian Economics: Sticky Prices

Question 1

According to New Keynesian theory,fluctuations in the target interest rate are not a good explanation of the business cycle because the model predicts that

A) consumption is constant.
B) labor is countercyclical.
C) average labor productivity is countercyclical.
D) output is countercyclical.

Answer 1

average labor productivity is countercyclical.

Question 2

A price may be sticky because

A) of monetary policy.
B) of menu costs.
C) of total factor productivity shocks.
D) of the monetary illusion.

Answer 2

of menu costs.

Question 3

In the New Keynesian model,

A) money is neutral.
B) money is fixed.
C) monetary policy has a real impact.
D) prices are countercyclical.

Answer 3

monetary policy has a real impact.

Question 4

Suppose that there is an increase in the demand for money. What is the appropriate monetary policy response in the New Keynesian sticky price model?

A) an increase in the interest rate target
B) no change in the interest rate target
C) a decrease in the interest rate target
D) an increase in government spending

Question 5

Why is it difficult to determine whether fluctuations in the target interest rate have led to business cycle fluctuations in the United States,according to the New Keynesian model?

A) Because the Federal Reserve may change the target interest rate according to economic conditions.
B) Because the target interest rate is nominal, not real.
C) Because inflation is not well measured.
D) Because money is neutral.

Question 6

Active stabilization policy can be rationalized in the New Keynesian model because

A) it makes it possible to obtain zero inflation.
B) the government knows best.
C) it counteracts the influence of unions.
D) it allows a faster return to economic efficiency.

Question 7

A money supply increase in the New Keynesian model is not neutral because

A) consumers are fooled into working harder.
B) the real interest falls, the quantity of output demanded rises, and firms supply more output.
C) productivity rises, increasing output supply.
D) bank lending rises.

Question 8

What fundamental problem does the New Keynesian model have,when compared to the data?

A) Investment fluctuates more than consumption.
B) The real wage moves too little.
C) Aggregate output demand does not matter.
D) Prices do not fluctuate in the right way.

Question 9

Menu costs are

A) very small costs.
B) the cost of differentiating prices for different goods.
C) the relative cost of raw materials compared to finished goods.
D) the cost of changing prices.

Question 10

In the New Keynesian model,the central bank achieves its interest rate target.

A) by announcing it.
B) by closing the output gap.
C) through money growth targeting.
D) by the supplying the quantity of money demanded at the target interest rate.

Question 11

What do we need to assume about firms in the sticky price model?

A) They accommodate any demand at the given price.
B) They hire until the real wage equals the average labor productivity.
C) They maximize only current profits.
D) They adapt the price to current conditions.

Question 12

The central bank in the New Keynesian model pursues a policy of

A) fixed money supply.
B) inflation between 2 and 3%.
C) zero inflation.
D) targeting the market interest rate.

Question 13

If prices in the New Keynesian model were perfectly flexible,then

A) there would be a role for monetary policy.
B) the output gap would be positive.
C) the equilibrium real interest rate would be the natural rate of interest.
D) the output gap would be negative.

Question 14

The output gap is

A) the difference between target output and realized output.
B) the difference between initial output and final output.
C) the difference between market-clearing output and actual output.
D) the difference between forecasted output and past output.

Question 15

The New Keynesian transmission mechanism for monetary policy is characterized by

A) helicopter drops of money.
B) money having an impact on the real interest rate.
C) banks using money injections for business loans.
D) the government buying goods with fresh money.

Question 16

Fluctuations in the target interest rate in the New Keynesian model lead to all of the following except

A) procyclical real wages.
B) procyclical employment.
C) countercyclical prices.
D) procyclical consumption.

Question 17

Stabilization policy is policy that seeks to

A) get zero inflation.
B) eliminate fluctuations.
C) eradicate unemployment.
D) maximize output.

Question 18

Suppose real output falls in the aggregate economy. Which is correct?

A) A real business cycle theorist thinks that there was a negative shock to total factor productivity, and that the government should therefore increase expenditures.
B) A New Keynesian thinks that the output gap has fallen, and central bank's interest rate target should rise.
C) A real business cycle theorist thinks that total factor productivity has risen, and that the government should do nothing .
D) none of the above.

Question 19

Why are aggregate demand shocks not a good explanation of business cycles in the New Keynesian model?

A) The wage is not constant.
B) Employment does not fluctuate.
C) Prices in the model are procyclical.
D) Consumption is not procyclical.

Question 20

In the New Keynesian model,the stabilization effects of fiscal and monetary policy are different because

A) the effects on the composition of output are different.
B) monetary policy does not work in a liquidity trap, but fiscal policy does.
C) monetary policy affects spending on goods indirectly; fiscal policy affects spending directly.
D) all of the above.

Question 21

Under monetary stabilization policy in the New Keynesian model,following a drop in output,the central bank should

A) increase the price level.
B) decrease the price level.
C) increase the interest rate.
D) decrease the interest rate.

Question 22

In response to a positive technology shock,which prediction of the sticky price model is difficult to reconcile with the data?

A) Output increases.
B) Employment decreases.
C) The price level decreases.
D) Money is procyclical.

Question 23

A classical objection to Keynesian sticky price models is that

A) it is easier for firms to change prices rather than change output.
B) it is cheaper for firms to change output rather than change prices.
C) sticky price models are internally inconsistent.
D) real shocks are more important than nominal shocks.

Question 24

In the New Keynesian model,if there is a decrease in anticipated future total factor productivity,then

A) there should be no change in monetary or fiscal policy.
B) the central bank's interest rate target should be increased.
C) government spending should fall, and the central bank's interest rate target should rise.
D) government spending should increase.

Question 25

To support the argument for an active role for government in stabilizing the economy,it must be true that

A) consumers are not rational and that not all wages and prices are flexible.
B) not all wages and prices are flexible and that government must be able to react quickly enough.
C) government must be able to react quickly enough and that shocks to the economy be primarily due to aggregate supply shocks.
D) shocks to the economy be primarily due to aggregate supply shocks and that consumers are not rational.

Question 26

A central bank can bring output back up to efficient level in the New Keynesian model by

A) decreasing the money supply.
B) increasing the money supply.
C) decreasing government expenses.
D) increasing government expenses.

Question 27

Under fiscal stabilization policy in the New Keynesian model,after a positive shock to output,

A) the government increases expenditures and the central bank increases the money supply.
B) the government increases expenditures and the central bank decreases the money supply.
C) the government decreases expenditures and the central bank increases the money supply.
D) the government decreases expenditures and the central bank decreases the money supply.

Question 28

Under fiscal stabilization policy in the New Keynesian model,after a negative shock to output,

A) the government increases expenditures and the central bank increases the money supply.
B) the government increases expenditures and the central bank decreases the money supply.
C) the government decreases expenditures and the central bank increases the money supply.
D) the government decreases expenditures and the central bank decreases the money supply.

Question 29

Under a liquidity trap in the New Keynesian model,

A) prices cannot be sticky.
B) monetary policy is ineffective.
C) the economy is always efficient.
D) fiscal policy is ineffective.

Question 30

Consider two alternative worlds: (i)the world works according the real business cycle model,and the central bank acts to stabilize the price level; (ii)the world works according to the New Keynesian sticky price model,and the central bank acts to make the output gap zero. Which is correct?

A) We would prefer to live in world (ii).
B) We would prefer to live in world (i).
C) The data cannot tell us whether we are living in world (i) or world (ii).
D) in either world, the central bank is irrelevant.

Question 31

Total factor productivity shocks are not a good explanation of economic fluctuations in the New Keynesian model for all the following reasons except

A) they do not generate output fluctuations.
B) employment drops when TFP increases.
C) the real wage drops when TFP increases.
D) they do not generate price fluctuations.

Question 32

Stabilization policy is to be applied if all of the following applies except

A) authorities have good information about the state of the economy.
B) policies can be applied quickly.
C) markets are out of equilibrium.
D) there is no output gap.