Deck 5: Inflation: Its Causes, Effects, and Social Costs

Question 1

If the transactions velocity of money remains constant while the quantity of money doubles, the:

A)price of the average transaction must double.
B)number of transactions must remain constant.
C)price of the average transaction multiplied by the number of transactions must remain constant.
D)price of the average transaction multiplied by the number of transactions must double.

Answer 1

price of the average transaction multiplied by the number of transactions must double.

Question 2

If the money supply increases 12 percent, velocity decreases 4 percent, and the price level increases 5 percent, then the change in real GDP must be _____ percent.

A)3
B)4
C)9
D)11

Answer 2

3

Question 3

Consider the money demand function that takes the form M / P = kY, where M is the quantity of money, P is the price level, k is a constant, and Y is real output. If the money supply is growing at a 10 percent rate, real output is growing at a 3 percent rate, and k is constant, what is the average inflation rate in this economy?

A)3 percent
B)7 percent
C)10 percent
D)13 percent

Answer 3

7 percent

Question 4

According to the quantity theory of money, if money is growing at a 10 percent rate and real output is growing at a 3 percent rate, but velocity is growing at increasingly faster rates over time as a result of financial innovation, the rate of inflation must be:

A)increasing.
B)decreasing.
C)7 percent.
D)constant.

Question 5

If there are 100 transactions in a year and the average value of each transaction is $10, then if there is $200 of money in the economy, transactions velocity is _____ times per year.

A)0.2
B)2
C)5
D)10

Question 6

Percentage change in P is approximately equal to the percentage change in:

A)M.
B)M minus the percentage change in Y.
C)M minus the percentage change in Y plus the percentage change in velocity.
D)M minus the percentage change in Y minus the percentage change in velocity.

Question 7

In the long run, according to the quantity theory of money and classical macroeconomic theory, if velocity is constant, then _____ determines real GDP and _____ determines nominal GDP.

A)the productive capability of the economy; the money supply
B)the money supply; the productive capability of the economy
C)velocity; the money supply
D)the money supply; velocity

Question 8

The definition of the transactions velocity of money is:

A)money multiplied by prices divided by transactions.
B)transactions divided by prices multiplied by money.
C)money divided by prices multiplied by transactions.
D)prices multiplied by transactions divided by money.

Question 9

The demand for real money balances is generally assumed to:

A)be exogenous.
B)be constant.
C)increase as real income increases.
D)decrease as real income increases.

Question 10

If income velocity is assumed to be constant, but no other assumptions are made, the level of _____ is determined by M.

A)prices
B)real GDP
C)transactions
D)nominal GDP

Question 11

The quantity theory of money assumes that:

A)income is constant.
B)velocity is constant.
C)prices are constant.
D)the money supply is constant.

Question 12

If the quantity of real money balances is kY, where k is a constant, then velocity is:

A)k.
B)1/k.
C)kP.
D)P/k.

Question 13

Given that M / P = kY, when the demand for money parameter, k, is large, the velocity of money is _____, and money is changing hands _____.

A)large; frequently
B)large; infrequently
C)small; frequently
D)small; infrequently

Question 14

According to the quantity theory of money, ultimate control over the rate of inflation in Canada is exercised by:

A)the Organization of the Petroleum Exporting Countries (OPEC).
B)the Department of Finance.
C)the Bank of Canada.
D)private citizens.

Question 15

If the demand for real money balances is proportional to real income, velocity will:

A)increase as income increases.
B)increase as income decreases.
C)vary directly with the interest rate.
D)be constant.

Question 16

If velocity is constant and, in addition, the factors of production and the production function determine real GDP, then:

A)the price level is proportional to the money supply.
B)real GDP is proportional to the money supply.
C)the price level is fixed.
D)nominal GDP is fixed.

Question 17

If the average price of goods and services in the economy equals $10 and the quantity of money in the economy equals $200,000, then real balances in the economy equal:

A)10.
B)20,000.
C)200,000.
D)2,000,000.

Question 18

Real money balances equal the:

A)sum of coin, currency, and balances in chequing accounts.
B)amount of money expressed in terms of the quantity of goods and services it can purchase.
C)number of dollars used as a medium of exchange.
D)quantity of money created by the Bank of Canada.

Question 19

The rate of inflation is the:

A)median level of prices.
B)average level of prices.
C)percentage change in the level of prices.
D)measure of the overall level of prices.

Question 20

When people want to hold _____ money, the income velocity of money increases, and the money demand parameter k _____.

A)more; increases
B)less; increases
C)more; decreases
D)less; decreases

Question 21

The opportunity cost of holding money is the:

A)nominal interest rate.
B)real interest rate.
C)overnight rate.
D)prevailing Treasury bill rate.

Question 22

The right of seigniorage is the right to:

A)levy taxes on the public.
B)borrow money from the public.
C)draft citizens into the armed forces.
D)print money.

Question 23

The ex ante real interest rate is based on _____ inflation, while the ex post real interest rate is based on _____ inflation.

A)expected; actual
B)core; actual
C)actual; expected
D)expected; core

Question 24

The real return on holding money is

A)the real interest rate.
B)minus the real interest rate.
C)the inflation rate.
D)minus the inflation rate.

Question 25

The ex post real interest rate will be greater than the ex ante real interest rate when the:

A)rate of inflation is increasing.
B)rate of inflation is decreasing.
C)actual rate of inflation is greater than the expected rate of inflation.
D)actual rate of inflation is less than the expected rate of inflation.

Question 26

If the nominal interest rate is 1 percent and the inflation rate is 5 percent, the real interest rate is:

A)1 percent.
B)6 percent.
C)-4 percent.
D)-5 percent.

Question 27

The real interest rate is equal to the:

A)amount of interest that a lender actually receives when making a loan.
B)nominal interest rate plus the inflation rate.
C)nominal interest rate minus the inflation rate.
D)nominal interest rate.

Question 28

If the real interest rate declines by 1 percent and the inflation rate increases by 2 percent, the nominal interest rate implied by the Fisher equation:

A)increases by 2 percent.
B)increases by 1 percent.
C)remains constant.
D)decreases by 1 percent.

Question 29

Evidence from the past 40 years in Canada supports the Fisher effect and shows that when the inflation rate is high, the _____ interest rate tends to be _____.

A)nominal; high
B)nominal; low
C)real; high
D)real; low

Question 30

If the real interest rate and real national income are constant, according to the quantity theory and the Fisher effect, a 1 percent increase in money growth will lead to rises in:

A)inflation of 1 percent and the nominal interest rate of less than 1 percent.
B)inflation of 1 percent and the nominal interest rate of 1 percent.
C)inflation of 1 percent and the nominal interest rate of more than 1 percent.
D)both inflation and the nominal interest rate of less than 1 percent.

Question 31

If the real return on government bonds is 3 percent and the expected rate of inflation is 4 percent, then the cost of holding money is _____ percent.

A)1
B)3
C)4
D)7

Question 32

When someone purchases a three-month Treasury bill, they cannot know the:

A)ex post real interest rate.
B)ex ante real interest rate.
C)nominal interest rate.
D)expected rate of inflation.

Question 33

Using average rates of money growth and inflation in the United States over many decades, Friedman and Schwartz found that decades of high money growth tended to have _____ rates of inflation and decades of low money growth tended to have _____ rates of inflation.

A)high; high
B)high; low
C)low; low
D)low; high

Question 34

The ex ante real interest rate is equal to the nominal interest rate:

A)minus the inflation rate.
B)plus the inflation rate.
C)minus the expected inflation rate.
D)plus the expected inflation rate.

Question 35

Equilibrium in the market for goods and services determines the _____ interest rate, and the expected rate of inflation determines the _____ interest rate.

A)ex ante real; ex ante nominal
B)ex post real; ex post nominal
C)ex ante nominal; ex post real
D)ex post nominal; ex post real

Question 36

"Inflation tax" means that:

A)as the price level rises, taxpayers are pushed into higher tax brackets.
B)as the price level rises, the real value of money held by the public decreases.
C)as taxes increase, the rate of inflation also increases.
D)in a hyperinflation, the chief source of tax revenue is often the printing of money.

Question 37

According to the quantity theory of money, a 5 percent increase in money growth increases inflation by _____ percent. According to the Fisher equation, a 5 percent increase in the rate of inflation increases the nominal interest rate by _____ percent.

A)1; 5
B)5; 1
C)1; 1
D)5; 5

Question 38

According to the quantity theory of money and the Fisher equation, if the money growth increases by 3 percent and the real interest rate equals 2 percent, then the nominal interest rate will increase:

A)2 percent.
B)3 percent.
C)5 percent.
D)6 percent.

Question 39

In the classical model, according to the quantity theory of money and the Fisher equation, an increase in money growth increases:

A)output.
B)velocity.
C)the nominal interest rate.
D)the real interest rate.

Question 40

The inflation tax is paid:

A)only by the central bank.
B)by all holders of money.
C)only by government bond holders.
D)equally by every household.

Question 41

If the nominal interest rate increases, then:

A)the money supply increases.
B)the money supply decreases.
C)the demand for money increases.
D)the demand for money decreases.

Question 42

The costs of unexpected inflation, but not of expected inflation, are:

A)menu costs.
B)the arbitrary redistribution of wealth between debtors and creditors.
C)unintended distortions of individual tax liabilities.
D)the costs of relative price variability.

Question 43

Which of the following would most likely be called a hyperinflation?

A)Price increases averaged 300 percent per year.
B)The inflation rate was 10 percent per year.
C)Real GDP grew at a rate of 12 percent over a year.
D)A stock market index rose by 1,000 points over a year.

Question 44

If the money supply is held constant, then an increase in the nominal interest rate will _____ the demand for money and _____ the price level.

A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease

Question 45

According to the classical theory of money, reducing inflation will not make workers richer because firms will increase product prices _____ each year and give workers _____ raises.

A)more; larger
B)more; smaller
C)less; larger
D)less; smaller

Question 46

In its most general formulation, the demand function for real balances depends on the level of income and the:

A)real interest rate.
B)nominal interest rate.
C)rate of inflation.
D)price level.

Question 47

The major source of government revenue in most countries that are experiencing hyperinflation is:

A)customs duties.
B)income taxes.
C)seigniorage.
D)borrowing.

Question 48

Consider the money demand function that takes the form (M / P)^d = Y / (4i), where M is the quantity of money, P is the price level, Y is real output, and i is the nominal interest rate. What is the average velocity of money in this economy?

A)i
B)4
C)1 / (4i)
D)0.25

Question 49

A rate of inflation that exceeds 50 percent per month is typically referred to as a:

A)conflagration.
B)hyperinflation.
C)deflation.
D)disinflation.

Question 50

Hyperinflations ultimately are the result of excessive growth rates of the money supply; the underlying motive for the excessive money growth rates is frequently a government's:

A)desire to increase prices throughout the economy.
B)need to generate revenue to pay for spending.
C)responsibility to increase nominal interest rates by increasing expected inflation.
D)inability to buy government securities through open-market operations.

Question 51

Inflation _____ the variability of relative prices and _____ the efficiency of the allocation of resources.

A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Question 52

If nominal wages cannot be cut, then the only way to reduce real wages is by:

A)adjustments via inflation.
B)unions.
C)legislation.
D)productivity increases.

Question 53

If the Bank of Canada announces that it will raise the money supply in the future but does not change the money supply today,

A)both the nominal interest rate and the current price level will decrease.
B)the nominal interest rate will increase and the current price level will decrease.
C)the nominal interest rate will decrease and the current price level will increase.
D)both the nominal interest rate and the current price level will increase.

Question 54

According to the classical theory of money, inflation does not make workers poorer because wages increase:

A)faster than the overall price level.
B)more slowly than the overall price level.
C)in proportion to the increase in the overall price level.
D)in real terms during periods of inflation.

Question 55

The costs of reprinting catalogues and price lists because of inflation are called:

A)menu costs.
B)shoeleather costs.
C)variable yardstick costs.
D)fixed costs.

Question 56

If the demand for money depends on the nominal interest rate, then via the quantity theory and the Fisher equation, the price level depends on:

A)only the current money supply.
B)only the expected future money supply.
C)both the current and expected future money supply.
D)neither the current nor the expected future money supply.

Question 57

If inflation was 6 percent last year and a worker received a 4 percent nominal wage increase last year, then the worker's real wage:

A)increased 4 percent.
B)increased 2 percent.
C)decreased 2 percent.
D)decreased 6 percent.

Question 58

In the case of an unanticipated increase in inflation:

A)creditors with an unindexed contract are hurt because they get less than they expected in real terms.
B)creditors with an indexed contract gain because they get more than they contracted for in nominal terms.
C)debtors with an unindexed contract do not gain because they pay exactly what they contracted for in nominal terms.
D)debtors with an indexed contract are hurt because they pay more than they contracted for in nominal terms.

Question 59

During a hyperinflation, real tax revenue of the government often drops substantially because of the:

A)delay between when a tax is levied and when it is collected.
B)significantly greater menu costs of printing tax forms.
C)additional deductions taken for increased shoeleather costs.
D)greater uncertainty associated with extreme rates of inflation.

Question 60

The inconvenience associated with reducing money holdings to avoid the inflation tax is called:

A)menu costs.
B)shoeleather costs.
C)variable yardstick costs.
D)fixed costs.

Question 61

According to the classical dichotomy, when the money supply decreases, _____ will decrease.

A)real GDP
B)consumption spending
C)the price level
D)investment spending

Question 62

Assume that a series of inflation rates is 1 percent, 2 percent, and 4 percent, while nominal interest rates in the same three periods are 5 percent, 5 percent, and 6 percent, respectively.
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a.What are the ex post real interest rates in the same three periods?
b.If the expected inflation rate in each period is the realized inflation rate in the previous period, what are the ex ante real interest rates in periods 2 and 3?
c.If someone lends in period 2, based on the ex ante inflation expectation in part b, will they be pleasantly or unpleasantly surprised in period 3 when the loan is repaid?

Question 63

The concept of monetary neutrality in the classical model means that an increase in the money supply growth rate will increase:

A)real GDP.
B)real interest rates.
C)nominal interest rates.
D)both saving and investment by the same amount.

Question 64

The classical dichotomy:

A)cannot hold if money is "neutral."
B)is said to hold when the values of real variables can be determined without any reference to nominal variables or the existence of money.
C)fully describes the world in which we live, especially in the short run.
D)arises because money depends on the nominal interest rate.

Question 65

Econoland finances government expenditures with an inflation tax.
a.Explain who pays the tax and how it is paid.
b.What are the costs associated with an inflation tax?

Question 66

An example of a nominal variable is the:

A)money supply.
B)quantity of goods produced in a year.
C)relative price of bread.
D)real wage.

Question 67

Assume that the demand for real money balance (M / P) is M / P = 0.6Y - 100i, where Y is national income, and i is the nominal interest rate (in percent). The real interest rate r is fixed at 3 percent by the investment and saving functions. The expected inflation rate equals the rate of nominal money growth.
a.If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what must i and P be?
b.If Y is 1,000, M is 100, and the growth rate of nominal money is 2 percent, what must i and P be?

Question 68

If the demand for money depends positively on real income and depends inversely on the nominal interest rate, what will happen to the price level today if the central bank announces (and people believe) that it will decrease the money growth rate in the future, but it does not change the money supply today?

Question 69

Variables expressed in terms of money are called _____ variables.

A)real
B)nominal
C)endogenous
D)exogenous

Question 70

Which of the following is an example of a relative price?

A)the real interest rate
B)the capital stock
C)the dollar wage per hour
D)the price level

Question 71

To end a hyperinflation, a government trying to reduce its reliance on seigniorage would:

A)print more money.
B)raise taxes and cut spending.
C)lower taxes and increase spending.
D)lower interest rates.

Question 72

A small country might want to use the money of a large country rather than print its own money if the small country:

A)is likely to be unstable, whereas the large country is likely to be stable.
B)is likely to be stable, whereas the large country is likely to be unstable.
C)needs the revenue for seigniorage.
D)wants to control its own inflation rate.

Question 73

Mary Tsai is paid $3,000 every 30 days. Her salary is deposited directly in her bank. She spends all her money at a constant rate over the 30 days and must pay cash. She can (1) withdraw all of the money at once; (2) withdraw half at once and the rest after 15 days; (3) withdraw one-third at once, one-third after 10 days, and one-third at 20 days; or (4) make any number of evenly spaced withdrawals. Each withdrawal costs her $2 in terms of time and inconvenience. For each day that Mary has a dollar in the bank, she gets .03 cents (.0003 per dollar) in interest. Thus, if she withdraws half of her money immediately and half in 15 days, she has $1,500 in the bank for 15 days and earns $6.75 interest.
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a.Create a table showing transaction costs, interest earned, and total net earnings (+) or cost (-) associated with one, two, three, or four withdrawals per month.
b.How many withdrawals per month lead to the largest net earnings? If Mary chooses this number, what will be her average amount of cash on hand over the 30 days?

Question 74

Most hyperinflations end with _____ reforms that eliminate the need for _____.

A)monetary; taxes
B)monetary; currency
C)fiscal; seigniorage
D)fiscal; currency

Question 75

If consumption depends positively on the level of real balances, and real balances depend negatively on the nominal interest rate, then:

A)the classical dichotomy still holds.
B)a rise in money growth leads to a fall in consumption and a rise in investment.
C)a rise in money growth leads to a rise in consumption and a fall in investment.
D)a rise in money growth leads to a rise in both consumption and investment.

Question 76

The characteristic of the classical model that the money supply does not affect real variables is called:

A)the monetary basis.
B)monetary policy.
C)the quantity theory of money.
D)monetary neutrality.

Question 77

Variables expressed in terms of physical units or quantities are called _____ variables.

A)real
B)nominal
C)endogenous
D)exogenous

Question 78

The theoretical separation of real and monetary variables is called:

A)the classical dichotomy.
B)monetary neutrality.
C)the Fisher effect.
D)the quantity theory of money.

Question 79

If consumption depends positively on the level of real balances and real balances depend negatively on the nominal interest rate, then the nominal interest rate:

A)declines when the money growth rate rises.
B)is unchanged when the money growth rate rises.
C)rises 1 percent for each 1 percent rise in the money growth rate.
D)rises less than 1 percent for each 1 percent rise in the money growth rate.

Question 80

Although "inflation is always and everywhere a monetary phenomenon," explain why:
a.the start of a hyperinflation is typically related to the fiscal policy situation.
b.the end of a hyperinflation is usually related to changes in fiscal policy.