Deck 22: Should Policy-Makers Be Restrained

Question 1

In which of the following political systems would a political business cycle be more likely to occur?

A) A parliamentary system.
B) Socialist- type economies.
C) A democracy with elections that occur on a regular basis.
D) A democracy with elections that occur on an irregular basis.
E) A royal kingdom.

Answer 1

A democracy with elections that occur on a regular basis.

Question 2

Which of the following would indicate that the "political business cycle" is a serious problem in a country?

A) Output increases substantially two years after each election.
B) Output increases substantially in the year before each election.
C) Unemployment remains substantially above the natural rate.
D) Large corporations continually switch the party they support.
E) Money growth is zero or negative.

Answer 2

Output increases substantially in the year before each election.

Question 3

Analysis of Australian growth rates 1901- 2010 shows that growth rate of output tends to be highest in which year of a federal government term?

A) The first year.
B) The second year.
C) The third year.
D) The fourth year.
E) The fifth year.

Answer 3

The first year.

Question 4

Arguments for placing restraints on policy makers fall into which of the following?

A) Policy makers understand completely how the economy operates.
B) Policy makers have good intentions, but end up doing more harm than good.
C) Policy makers do what is best for them, not necessarily what is best for the country.
D) Both A and B.
E) Both B and C.

Question 5

Game theory analysis of macro policy suggests that as voters become more short- sighted:

A) policy makers will be tempted to raise taxes.
B) policy makers will be forced to cut spending.
C) policy makers will adopt policies today to achieve balanced budgets in the future.
D) policy makers will be tempted to cut taxes.
E) policy makers will be forced to balance the budget.

Question 6

Assume that there exists uncertainty about the impact of monetary policy on the macroeconomy. Given this information, it would be most appropriate for the central bank to increase money growth:

A) by less than the increase that will yield the desired response.
B) only after it is certain that the economy has entered a recession.
C) by more than the increase that will yield the desired response.
D) by an amount equal to the increase that will yield the desired response.
E) at the midpoint of a recession.

Question 7

Once people believe the RBA's commitment to keep unemployment at the natural rate, the RBA can increase unemployment above the natural rate:

A) in the short run, but not in the medium run.
B) in both the short run and the medium run.
C) in both the short run and the medium run, but only after changing peoples' expectations.
D) in the medium run and the long run.
E) in the medium run, but not the short run.

Question 8

One surprising insight from viewing policy as a "game" is that:

A) money growth has little or no impact on inflation in the long run.
B) decreasing money growth may substantially increase the rate of inflation in the long run.
C) central bankers should project an image of being conservative on economic policy matters, regardless of their personal views.
D) uncertainty over the impact of policy makes little difference in designing an optimal policy.
E) it is more difficult to control inflation when the central bank is highly independent.

Question 9

Which of the following policies toward kidnappings would you recommend to authorities?

A) State policy of negotiations. If a kidnapping occurs, authorities should negotiate.
B) State policy of no negotiations. If a kidnapping occurs, authorities should negotiate.
C) The need to negotiate depends on the amount of ransom demanded.
D) State policy of negotiations. If a kidnapping occurs, authorities should not negotiate.
E) State policy of no negotiations. If a kidnapping occurs, authorities should not negotiate.

Question 10

The ratio of debt to GDP in Australia:

A) has decreased steadily over the past 70 years.
B) has remained remarkably stable over the last 70 years.
C) typically rises significantly during wartime periods.
D) was higher in the 1980s than at any other time during the century.
E) has never decreased in the last 70 years.

Question 11

Growth rates of output during the terms of office of Australian governments, 1901 - 2010 indicate that:

A) there is a small difference in average growth rates between the first year and the last year of the governments.
B) a poor economy is an important reason for governments losing office.
C) there is no evidence for successful manipulation of the economy.
D) All of the above.
E) None of the above.

Question 12

Assume that political business cycles do not exist. Given this assumption, we would expect, all else fixed, the output growth to be highest in which period?

A) Just prior to an election.
B) In the second year of a government.
C) In the first year of a government.
D) Just after an election.
E) None of the above.

Question 13

As uncertainty about the effects of policy on output decreases, we would expect that:

A) policy makers would more frequently implement fine tuning policies.
B) policy makers would implement more active policies.
C) policy makers would implement less active policies.
D) Both A and B.
E) Both A and C.

Question 14

In 1994, Republicans introduced their "Contract with America". This plan:

A) included a PAYGO rule.
B) introduced a balanced- budget amendment to the Constitution.
C) would allow for more policy fine tuning.
D) would restrict the ability of monetary policy to affect the economy in the short run.
E) would make the Federal Reserve even more independent than it already is.

Question 15

Based on an analysis of output growth rates under right wing and left wing governments in Australia, which of the following is true?

A) Growth rates are slightly higher under right- wing governments.
B) Growth rates are significantly higher under left- wing governments.
C) Growth rates are significantly higher under right- wing governments.
D) There is no difference in growth rates between the right- wing and the left- wing governments.
E) Growth rates are slightly higher under left- wing governments.

Question 16

To solve the "time inconsistency" problem in macro policy, a nation may well have to:

A) present policy moves to the public, for example, in a referendum.
B) use the courts to settle policy disputes.
C) restrict itself in the present from taking certain policy moves in the future.
D) lift all restrictions on future policy moves.
E) make the central bank more responsive to the popular will.

Question 17

Analysis of macro policy and theory has resulted in which of the following views?

A) There should be some self- restraint by policy makers in the use of fiscal or monetary policy.
B) Economists know more these days to allow for more active policy fine tuning.
C) A constitutional amendment is the only hope for constraining fiscal policy.
D) Popular elections for the head of the central bank is the most effective way to constrain monetary policy.
E) The head of the central bank should be appointed by the prime minister.

Question 18

Which of the following is the most powerful argument for putting restraints on policy makers (as opposed to self- restraint by policy makers themselves)?

A) Uncertainty about the timing of policy impacts.
B) Uncertainty about the natural rate of unemployment.
C) Time inconsistency.
D) Disagreements about the proper structure of an econometric model.
E) Uncertainty about Okun's coefficient.

Question 19

Which of the following would be a cause of time inconsistency of monetary policy?

A) The central bank has a legislated inflation target.
B) The central banker is conservative.
C) The central bank cares about unemployment as well as inflation.
D) The general public have adaptive expectations.
E) The general public have rational expectations.

Question 20

Which of the following best defines time inconsistency?

A) The increasing inaccuracy of econometric models as the time horizon becomes longer.
B) The effect of economic uncertainty on short- run stabilisation policy.
C) The tendency for the rise in output to be greater in the early years of a president's term, and smaller in the later years.
D) The tendency for policy makers to deviate from a pre- announced optimal policy once agents in the economy have adjusted their behaviour and expectations based on the pre- announced policy.
E) The effects of political electoral cycles on the business cycle.

Question 21

Fine tuning is a policy in which policy makers:

A) try to maintain a given path of the real exchange rate.
B) try to minimise the deviations of actual output from the natural level of output.
C) try to maintain a given rate of growth in the nominal money supply.
D) try to achieve zero inflation.
E) try to minimise fluctuations in interest rates.

Question 22

In macroeconomics, game theory focuses on the strategic interactions between which of the following groups of agents?

A) Individuals and firms.
B) Academic economists and business economists.
C) Individuals, firms and policy makers.
D) Policy makers and economic forecasters.
E) Individuals, firms and economic forecasters.

Question 23

Discuss the time inconsistency problem and explain how it relates to monetary policy.

Question 24

All of the macroeconometric models currently in use:

A) originate with commercial firms who sell their forecasts to other firms and governments.
B) originate with government or international agencies.
C) are different in structures and assumptions used.
D) originate in Australia.
E) incorporate rational expectations into their predictions.

Question 25

Who is best known for arguing about the long and variable lags of monetary policy?

A) Phillips.
B) Modigliani.
C) Lucas.
D) Friedman.
E) Keynes.

Question 26

What were some of the key features in terms of fiscal policy of the Stability and Growth Pact signed in 1997 by would- be members of the Euro?

Question 27

The leading macroeconometric models currently in use in Australia and the U.S.:

A) predict the same duration of the effects of a policy change.
B) predict the same response of output to a monetary expansion.
C) rely on the same set of assumptions.
D) demonstrate that there is substantial uncertainty about policy effects.
E) yield identical forecasts.

Question 28

The existence of the time inconsistency problem in macro policy suggests which of the following?

A) Use fiscal and monetary policy to fine tune the economy.
B) Appoint someone who is more conservative than the rest of the government to head the central bank.
C) Intervene frequently in the foreign exchange market.
D) Reduce the independence of the central bank.
E) Eliminate rational expectations from econometric models used for forecasting.

Question 29

Research suggests that the less independent the central bank:

A) the more stable the government.
B) the larger the budget deficit.
C) the higher the rate of inflation.
D) the lower the likelihood of a "war of attrition" over policy.
E) the smaller the time inconsistency problem in making policy.

Question 30

To deal with the time inconsistency problem associated with monetary policy, some have suggested that:

A) the central bank implement expansionary monetary policy prior to election years.
B) the contract of the central bank governor be reviewed regularly by the parliament.
C) elected officials should have a direct influence on the implementation of monetary policy.
D) the head of the central bank be chosen by election.
E) the central bank be made more independent.

Question 31

Which of the following is correct about Australian output growth over the past 100 years?

A) It has been dramatically lower than average during the year before an election.
B) It has been slightly higher than average during the year before an election, but not much higher.
C) It has been dramatically lower before an election than after an election.
D) It has been dramatically higher than average during the year before an election.
E) It has been slightly lower than average during the year before an election, but not much lower.

Question 32

Suppose a government implements rules that result in a more independent central bank. What effect do you think this more independent central bank will eventually have on money growth and inflation in that country? Explain.

Question 33

Assume a country has federal elections every three years. If a political business cycle exists in this country, explain any differences in the average annual growth rates of output for each year of a typical government.

Question 34

Which of the following statements is true about Australia over the past one hundred years?

A) There is no strong evidence of political business cycles in Australia.
B) Under either party, output growth has been generally lower in the year preceding an election than in other years.
C) The debt- to- GDP ratio has been roughly constant.
D) Both A and B.
E) Both B and C.

Question 35

Those who are concerned about balanced budget amendments typically argue that:

A) they would make fluctuations in output around the natural level of output greater.
B) they would reduce national saving.
C) they would cause interest rates to be higher than they otherwise would be.
D) they would reduce aggregate demand.
E) they would increase spending in a recession.

Question 36

The idea that the economy operates like a complicated, predictable machine is an important aspect of:

A) attrition theory.
B) the theory of strategic interaction.
C) game theory.
D) time inconsistency theory.
E) optimal control theory.

Question 37

Econometric models of the U.S. economy generally agree:

A) that an increase in money growth will increase output in the short run.
B) on the quantitative impact of monetary policy over a horizon of several years.
C) that rational expectations is the best way to generate policy forecasts.
D) that an increase in money growth will decrease output in the long run.
E) that an increase in money growth will decrease output in the short run.

Question 38

Analysis of U.S. budget deficits in the United States between 1990 and 2000 indicates that which of the following is primarily responsible for the reduction in the budget deficit?

A) Increase in tax revenues.
B) Decrease in spending and increase in tax revenues.
C) Increases in tax rates.
D) Decrease in spending.
E) Lower interest rates.

Question 39

Research for a number of OECD countries suggest that inflation will be lower:

A) where the terms of the heads of central banks coincide with the terms of elected officials.
B) if the heads of central banks are chosen by election.
C) the more independent the central bank.
D) when there are close ties between the central bank and the government.
E) the less independent the central bank.

Question 40

Given the uncertainty about the effects of macro policy, economists generally propose that:

A) macro policies should be more active, the lower the level of unemployment or inflation.
B) money growth should be set at zero by constitutional amendment.
C) changes in money growth should only be used for fine tuning the economy, not for correcting large imbalances (such as high inflation).
D) policymakers should stop well short of fine tuning.
E) elected officials should have more input in the determination of monetary policy.

Question 41

Discuss in terms of macroeconomic contexts when wars of attrition may arise. Can you think of a recent economic episode that illustrates this macroeconomic game situation?

Question 42

Balanced budget amendments are believed to be destabilising. Explain why this is so.

Question 43

Explain what a PAYGO rule is.

Question 44

Explain whether uncertainty should cause policy makers to do more or do less to stabilise the economy.

Question 45

First, what can be done to increase central bank credibility? Second, why is central bank credibility important?