Deck 13: Business Cycle Models With Flexible Prices and Wages

Question 1

In the New Keynesian model, suppose that the output gap is initially zero, there is an increase in money demand, and the central bank wants to keep the output gap at zero. What happens?

A)Investment goes down.
B)Output goes up.
C)Money supply goes up.
D)Consumption goes up.
E)Employment goes down.

Answer 1

C

Question 2

A key criticism of New Keynesian models is

A)monetary policy is irrelevant.
B)they don't explain why prices are sticky.
C)old Keynesian models are better.
D)they do not fit the data as well as real business cycle models.
E)they are never used in practice.

Answer 2

B

Question 3

A classical objection to Keynesian sticky price models is that

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

Answer 3

C

Question 4

In the New Keynesian model, the central bank's policy target is

A)aggregate output.
B)the interest rate.
C)unemployment.
D)the money supply.
E)money demand.

Question 5

The key difference between Keynesian and Classical economists is

A)Keynesians believe that monetary and fiscal policies are detrimental to the economy.
B)Keynesians believe wages and prices are perfectly flexible.
C)Keynesians favour a role for government in managing the economy.
D)Classical economists propose a "menu cost" model.
E)Classical economists favour a role for government in managing the economy.

Question 6

In the New Keynesian model, an increase in the money supply

A)increases output and increases the real interest rate.
B)increases output and decreases the real interest rate.
C)decreases output and increases the real interest rate.
D)decreases output and increases the real wage rate.
E)decreases output and decreases the real interest rate.

Question 7

The advantage of government intervention when a shock hits an economy is

A)the composition of output changes.
B)the real interest rate remains unchanged.
C)the real interest rate rises.
D)an efficient outcome is achieved faster.
E)the price level rises.

Question 8

In the New Keynesian model, an increase in the money supply

A)causes a reduction in the price level.
B)causes an equiproportional increase in the price level.
C)has no effect on the price level.
D)causes a less than proportional increase in the price level.
E)causes a more than proportional increase in the price level.

Question 9

If the central bank in a New Keynesian model can always reduce the output gap to zero

A)the price level will be procyclical.
B)investment will be procyclical if there are total factor productivity shocks.
C)consumption will be countercyclical if there are total factor productivity shocks.
D)the price level will be countercyclical.
E)this would be inefficient.

Question 10

The Yd(IS)curve is downward sloping to reflect the

A)positive relationship between aggregate output and employment.
B)negative relationship between aggregate output and the real wage rate.
C)positive relationship between aggregate output and the real wage rate.
D)negative relationship between aggregate output and the real interest rate.
E)positive relationship between aggregate output and total factor productivity.

Question 11

In the New Keynesian model, an increase in the money supply

A)decreases the real interest rate, increases real aggregate output, increases the real wage rate, and decreases employment.
B)increases the real interest rate, decreases real aggregate output, decreases the real wage rate, and increases employment.
C)decreases the real interest rate, increases real aggregate output, decreases the real wage rate, and increases employment.
D)decreases the real interest rate, decreases real aggregate output, decreases the real wage rate, and increases employment.
E)decreases the real interest rate, increases real aggregate output, increases the real wage rate, and increases employment.

Question 12

According to real business cycle theorists, the tendency of money to lead output may be due to

A)the tendency for bank loans to expand in advance of real activity that will occur at a later date and the Bank of Canada's use of all available information in trying to stabilize the price
Level.
B)the Bank of Canada's use of all available information in trying to stabilize the price level and the Bank of Canada's use of all available information in trying to stabilize the level of
Economic activity.
C)the Bank of Canada's use of all available information in trying to stabilize the level of economic activity and government spending shocks, which lead to later changes in
Economic activity.
D)government spending shocks, which lead to later changes in economic activity, and the tendency for bank loans to expand in advance of real activity that will occur at a later date.
E)the Bank of Canada's use of all available information in trying to stabilize business cycle fluctuations and the price level.

Question 13

The behaviour of the Solow residual suggests that when current total factor productivity increases

A)such increases are temporary, so we can draw no conclusions about the likely behaviour of future total factor productivity.
B)are typically temporary and have no influence on future levels of aggregate real GDP.
C)it becomes more difficult to predict future total factor productivity.
D)future total factor productivity is likely to decrease.
E)future total factor productivity is also likely to increase.

Question 14

In the New Keynesian model, the output demand curve represents combinations of

A)the real interest rate and the level of output at which the goods market and the labour market are in equilibrium.
B)the real interest rate and the price level at which the goods market is in equilibrium.
C)the price level and the level of output at which the goods market is in equilibrium.
D)the real interest rate and the level of output at which the goods market is in equilibrium.
E)the price level and the level of output at which the goods market and the labour market are in equilibrium.

Question 15

In 1936, Keynes described his views on the economy in

A)Macroeconomic Stabilization Policy in Canada.
B)Some Evidence on the Importance of Sticky Prices.
C)The General Theory of Employment, Interest, and Money.
D)Essays in Positive Economics.
E)Mr. Keynes and the Classics; A Suggested Interpretation.

Question 16

The observed correlation between the price level and real GDP may be low because

A)the central bank acts to target the price level.
B)consumption is procyclical.
C)Milton Friedman has passed away.
D)money demand does not depend on income.
E)money demand increases when the nominal interest rate rises.

Question 17

The phenomenon of underutilization of labour during a recession is called

A)investing in human capital.
B)labour stockpiling.
C)retraining labour.
D)labour force stabilization.
E)labour hoarding.

Question 18

Two business cycle facts that are less easily explained by the real business cycle are that

A)the nominal money supply is procyclical and leads the business cycle.
B)the nominal money supply is procyclical and is a leading indicator.
C)the nominal money supply is procyclical and is coincident with the business cycle.
D)the nominal money supply is procyclical and lags the business cycle.
E)money and prices are both acyclical.

Question 19

According to the New Keynesian model, after a negative shock to output

A)the government increases expenditures and the central bank increases its target rate.
B)the government decreases expenditures and the central bank decreases its target rate.
C)the government decreases expenditures and the central bank increases its target rate.
D)the government leaves expenditures unchanged and the central bank increases its target rate.
E)the government increases expenditures and the central bank decreases its target rate.

Question 20

According to real business cycle theorists, an increase in total factor productivity could lead to an increase in the nominal money supply due to

A)the cyclical behaviour of tax collections and attempts by the Bank of Canada to stabilize real output.
B)Bank of Canada attempts to stabilize the price level and banking sector expansion of deposit money.
C)Bank of Canada attempts to stabilize real output and the price level.
D)Bank of Canada attempts to stabilize business cycle fluctuations.
E)banking sector expansion of deposit money and the cyclical behaviour of tax collections.

Question 21

A government policy that is consistent with real business cycle theory would be for

A)the monetary authority to expand and contract the nominal money supply in response to shocks to total factor productivity.
B)government to smooth out tax distortions over time.
C)government to vary its spending in response to shocks to total factor productivity.
D)government to vary its spending and taxation decreases in response to shocks that affect the price level.
E)government to vary its lump-sum tax collections in response to changes in total factor productivity.

Question 22

The natural rate of interest is

A)the real interest rate when wages and prices are fixed.
B)the nominal rate of interest.
C)the market-clearing interest rate.
D)the Bank of Canada's target interest rate.
E)the real interest rate minus the expected inflation rate.

Question 23

The New Keynesian model has the property that in the short run

A)money is neutral.
B)government policy is neutral.
C)total factor productivity is neutral.
D)the Bank of Canada is neutral.
E)money is not neutral.

Question 24

The Keynesian transmission mechanism for monetary policy asserts that changes in the money supply

A)affect the price level, which affects the level of aggregate supply.
B)affect the price level, which affects the IS curve.
C)affect the price level, which affects the level of aggregate demand.
D)affect real interest rates, which affect the level of aggregate supply.
E)affect real interest rates, which affect the level of aggregate demand.

Question 25

Different business cycle models

A)support monetary policy but not fiscal policy.
B)have contradictory implications for monetary and fiscal policy.
C)have similar implications for monetary and fiscal policy.
D)all imply that active government intervention is detrimental.
E)all justify active government stabilization policy.

Question 26

In the New Keynesian model, an increase in current total factor productivity

A)increases employment.
B)leaves employment unchanged.
C)decreases unemployment.
D)decreases employment.
E)decreases output.

Question 27

The New Keynesian model and the monetary intertemporal model are essentially identical EXCEPT that

A)nominal and real interest rates are permitted to fluctuate.
B)Bank of Canada policy is restricted.
C)total factor productivity is neutral.
D)the price level is not sufficiently flexible for the goods market to clear in the short run.
E)money is neutral.

Question 28

An important critique of real business cycle theory is the belief that cyclical movements in total factor productivity

A)are too small to account for the size of fluctuations in real GDP.
B)does not explain the overall fluctuations in the business cycle.
C)may, in part, be an artifact of measurement error.
D)rarely occur.
E)lead to imperceptible changes in labour demand.

Question 29

The output gap is the difference between

A)output demand and output supply.
B)the market-clearing level of output and the actual level of output, Ym - Y*.
C)the Bank of Canada's output target and the market-clearing level of output.
D)nominal output and real output.
E)current and future total factor productivity.

Question 30

Changes in the money supply in the New Keynesian model are NOT a likely explanation of the typical business cycle, because the model counterfactually predicts that

A)the real wage is procyclical.
B)investment is procyclical.
C)the real wage is countercyclical.
D)employment is procyclical.
E)consumption is procyclical.

Question 31

According to the New Keynesian model, in a liquidity trap

A)neither monetary or fiscal policy is effective.
B)monetary policy is more effective than fiscal policy.
C)fiscal policy is more effective than monetary policy.
D)fiscal and monetary policy are equally effective.
E)fiscal policy has little role.

Question 32

In the New Keynesian model, an increase in current total factor productivity

A)shifts output supply right and opens a positive output gap.
B)shifts output demand left and opens a negative output gap.
C)shifts output demand right and opens a positive output gap.
D)shifts output supply right and opens a negative output gap.
E)shifts output supply left and opens a negative output gap.

Question 33

Changes in the money supply in the New Keynesian model is NOT a likely explanation of the typical business cycle, because the model counterfactually predicts that

A)consumption is procyclical and the price level is procyclical.
B)the real money supply is procyclical and consumption is procyclical.
C)the real wage is countercyclical and the real money supply is procyclical.
D)consumption is procyclical and the real wage is countercyclical.
E)the price level is procyclical and the real wage is countercyclical.

Question 34

Menu cost models

A)explain the cost of menus.
B)are identical to real business cycle models.
C)are models in which prices can be changed at a cost.
D)were constructed by John Maynard Keynes.
E)are models of the restaurant industry.

Question 35

Endogenous money is where the money supply is NOT determined by the monetary authority, but

A)by the federal government.
B)by the private sector.
C)responds to conditions in the economy.
D)the consumer.
E)by total money demand in the economy.

Question 36

Procyclical total factor productivity (TFP)could be caused by

A)the labour input to production is countercyclical.
B)lower average labour productivity when real GDP is high.
C)when TFP rises, real GDP falls.
D)measurement error.
E)lower investment when real GDP is high.

Question 37

In the New Keynesian model, if there are shocks to government spending, and the central bank always reduces the output gap to zero

A)the model replicates the key business cycle facts.
B)investment is procyclical.
C)employment is countercyclical.
D)consumption is countercyclical.
E)the money supply is constant.

Question 38

Most central banks, including the Bank of Canada

A)target the real interest rate.
B)target a particular monetary aggregate.
C)target the money supply.
D)target the price level.
E)refrain from stabilization policy.

Question 39

The Keynesian view implies that there is a role for monetary and fiscal policy in stabilizing the economy in response to aggregate shocks because

A)money is neutral.
B)business cycles have many causes.
C)these policies are highly effective in raising total factor productivity.
D)prices and wages are slow to clear markets.
E)comovement of aggregate variables does not generally happen during the business cycle.

Question 40

An increase in future total factor productivity shifts the

A)M curve to the right.
B)Yd curve to the left.
C)Yd curve to the right.
D)Ys curve to the left.
E)Ns curve to the right.

Question 41

The real business cycle model best explains the procyclicality of the nominal money by

A)uncorrelated money.
B)an unpredictable Bank of Canada.
C)endogenous money.
D)exogenous money.
E)monetary neutrality.

Question 42

A traditional liquidity trap is problematic for a New Keynesian policy maker because there is a

A)strong incentive to create inflation in the long run.
B)strong incentive to create deflation in the long run.
C)negative output gap but the interest rate target remains too low.
D)negative output gap but the interest rate cannot go below zero.
E)positive output gap but the interest rate cannot go below zero.

Question 43

The basic real business cycle model has some difficulty explaining why

A)the real wage is procyclical.
B)the money supply is procyclical.
C)consumption is procyclical.
D)investment is procyclical.
E)the price level is countercyclical.

Question 44

Comovement between nominal and real variables

A)was not historically a strong regularity in Canada, but now it is.
B)cannot be explained.
C)was observed by Friedman Schwartz in the historical Canadian data.
D)was observed by Friedman and Schwartz after the 2008 2009 recession.
E)was once a strong regularity in Canadian data, but is no longer.

Question 45

In the real business model, a persistent increase in total factor productivity causes

A)the output demand curve shifting less than the output supply curve.
B)the money supply to shift right.
C)the price level to rise.
D)real wages to fall.
E)real interest rates to rise.

Question 46

Compared to monetary policy, fiscal policy leads to

A)more efficient outcomes.
B)larger changes in output.
C)more private spending relative to public.
D)more stable prices.
E)the price level fluctuates more in the short run.

Question 47

In the New Keynesian model, an increase in current total factor productivity

A)increases output and increases employment.
B)increases output and increases the real interest rate.
C)decreases output and increases the real interest rate.
D)decreases output and decreases employment.
E)does not affect output and decreases employment.

Question 48

Negative nominal interest rates work because

A)they are good for banks.
B)they cause consumption to go down.
C)they reduce investment.
D)nominal interest rates cannot go above zero.
E)they act to reduce the output gap.

Question 49

The Yd(IS)curve in the New Keynesian model represents output demand at different levels of

A)the price level.
B)the real interest rate.
C)real wage rate.
D)total factor productivity.
E)the nominal wage rate.

Question 50

New Keynesian economics refers to

A)the IS-LM model.
B)models of real business cycles with sticky prices.
C)models that do not support a role for fiscal or monetary policy.
D)the monetarist approach.
E)the work of Milton Friedman.

Question 51

In the New Keynesian model, an increase in current government spending

A)decreases output and increases the real wage rate.
B)decreases output and decreases the real interest rate.
C)decreases output and increases the real interest rate.
D)increases output and decreases the real interest rate.
E)increases output and leaves the real interest rate unchanged.

Question 52

In the New Keynesian sticky wage model, an increase in the money supply

A)shifts the output supply curve to the left.
B)shifts the output demand curve to the right.
C)immediately closes the output gap.
D)shifts the output demand curve to the left.
E)shifts the output supply curve to the right.

Question 53

Keynesian sticky price models are typically called

A)menu cost models.
B)administered cost models.
C)faulty pricing models.
D)inflation forecasting models.
E)classical models.

Question 54

If a shock results in a positive output gap and the government's policy choice is to do nothing

A)the government will immediately implement expansionary fiscal policy.
B)the central bank will immediately increase the money supply and close the output gap.
C)it will be detrimental to the economy.
D)the economy will be prevented from returning to equilibrium.
E)the price level will fall, the interest rate will fall, and output will rise, closing the gap.

Question 55

Prices may be sticky in the short run because

A)firms are set in their ways of conducting business.
B)it's too costly for firms to change prices.
C)government regulated money prices.
D)there is no upward pressure on prices in the market.
E)consumers are irrational and do not react fast enough.

Question 56

An important critique of real business cycle theory is that during a recession

A)there is underutilization of labour and the real wage decreases.
B)there is overutilization of labour and overutilization of the aggregate capital stock.
C)there is overutilization of labour and the wage rate is constant.
D)there is underutilization of labour and total factor productivity increases.
E)there is underutilization of labour and underutilization of the aggregate capital stock.

Question 57

In the New Keynesian model, an increase in future total factor productivity

A)shifts the output supply curve to the right.
B)does not impact current output.
C)shifts the output supply curve to the left.
D)shifts the output demand curve to the right.
E)shifts the output demand curve to the left.

Question 58

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)consumers are not rational and shocks to the economy are primarily due to aggregate demand.
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.
E)not all wages and prices are flexible and that government must be able to react quickly enough.

Question 59

In the real business cycle model, a persistent increase in total factor productivity

A)has no effect on the real interest rate.
B)has a theoretically ambiguous effect on the nominal interest rate.
C)unambiguously increases the real interest rate.
D)unambiguously decreases the real interest rate.
E)has a theoretically ambiguous effect on the real interest rate.

Question 60

In comparing the outcomes of increasing government spending to reduce Keynesian unemployment as opposed to increasing the money supply, the increase in government spending
Results in

A)higher consumption and higher output.
B)lowers consumption and the real wage rate.
C)lower consumption and higher output.
D)higher consumption and lower output.
E)lower consumption and lower output.

Question 61

In the long run, most Keynesians believe

A)government policy is neutral.
B)total factor productivity is neutral.
C)the Bank of Canada is neutral.
D)money is neutral.
E)money is not neutral.

Question 62

If there is a liquidity trap in the New Keynesian model then

A)fiscal policy is irrelevant.
B)conventional monetary easing works well.
C)government spending is trapped.
D)the nominal interest rate is at its lower bound.
E)prices cease to be sticky.

Question 63

The real business cycle model replicates the key business cycle regularities

A)with equal magnitudes of change.
B)qualitatively but not quantitatively.
C)both qualitatively and quantitatively.
D)neither qualitatively nor quantitatively.
E)quantitatively but not qualitatively.

Question 64

The main difference between the New Keynesian model and the basic monetary intertemporal model is that in the New Keynesian model

A)menu costs are insignificant.
B)the price level is sticky in the short run.
C)firms are backward-looking.
D)wages are sticky in the short run.
E)prices adjust quickly to equate the supply and demand for goods.

Question 65

The argument that the nominal wage is fixed because of long-term labour contracts

A)closely fits the real world.
B)means that productivity shocks are an important cause of business cycles.
C)explains sticky price models.
D)explains equilibrium business cycle models.
E)does not take into account why such a contract would be written.

Question 66

A negative nominal interest rate may not be good policy because

A)could produce inefficiencies in the banking system.
B)it makes investment go down.
C)could produce inefficiencies at Federal Reserve Banks.
D)it makes the output gap go up.
E)it makes consumers too optimistic, and the economy overheats.

Question 67

In the New Keynesian model, an increase in current total factor productivity shifts the

A)output demand curve to the left.
B)production function to the right.
C)production function up.
D)output demand curve to the right.
E)output demand curve and production function to the left.

Question 68

Real business cycle theory was introduced by

A)Thomas Cooley and Gary Hansen.
B)Finn Kydland and Edward Prescott.
C)Robert Lucas.
D)Milton Friedman and Anna Schwartz.
E)Milton Friedman and Robert Lucas.

Question 69

The Yd(IS)curve in the New Keynesian model is identical to which of the following in the intertemporal monetary model?

A)the labour supply curve
B)the output supply curve
C)the labour demand curve
D)the output demand curve
E)the total factor productivity curve

Question 70

The New Keynesian model predicts that

A)Keynesian transmission mechanism for monetary policy is initially through the private sector.
B)monetary policy is unobservable and unpredictable.
C)monetary policy is not as effective as fiscal policy.
D)monetary policy causes business cycles.
E)money is neutral.

Question 71

When there is Keynesian unemployment in the New Keynesian model, a Pareto optimum can be reached by

A)decreasing the money supply or by increasing current government spending.
B)increasing the money supply or by decreasing current government spending.
C)increasing nominal wages and increasing the money supply.
D)decreasing the money supply or by decreasing current government spending.
E)increasing the money supply or by increasing current government spending.

Question 72

An increase in the demand for investment goods causes

A)a decrease in real interest rates.
B)an increase in real interest rates.
C)a decrease in the real wage.
D)a leftward shift of the output demand curve.
E)a rightward shift of the output demand curve.

Question 73

When the central bank targets the interest rate

A)the target interest rate must be changed eight times a year.
B)the money supply is sticky.
C)it does so by adjusting the money supply.
D)the money supply is fixed.
E)the money supply is reduced.

Question 74

An important feature of the New Keynesian model is that

A)the labour market may not clear.
B)the goods market always clears.
C)all markets clear.
D)the money market may not clear.
E)the labour market always clears.

Question 75

Measurement errors of changes in the Solow residual during recessions are most likely caused by

A)underutilization of capital, but not of labour.
B)constant real wage rate.
C)mismeasurement of real GDP.
D)underutilization of labour, but not of capital.
E)underutilization of labour and capital.

Question 76

Stabilization policy refers to using government policy

A)to promote competition among firms and industries.
B)to promote technology development.
C)to smooth out business cycles.
D)to set up a legal system.
E)to alter commodity prices.

Question 77

Crowding out of private expenditure occurs when

A)increases in the price level lowers the real wage.
B)the money supply is decreased.
C)the money supply is increased.
D)government spending decreases.
E)government spending increases.

Question 78

In the New Keynesian model, an increase in current government spending shifts

A)the output supply curve to the right.
B)the production function up.
C)the output demand curve to the left.
D)the output supply curve to the left.
E)the output demand curve to the right.

Question 79

In the real business cycle model, a persistent increase in total factor productivity

A)increases the real wage and decreases the price level.
B)decreases the real wage and increases the price level.
C)results in no change in the real wage and the price level.
D)increases the real wage and increases the price level.
E)decreases the real wage and decreases the price level.

Question 80

If there are total factor productivity shocks in the New Keynesian model, and the central bank always reduces the output gap to zero

A)the New Keynesian model will produce the same data as the real business cycle model only if the central bank pegs the price level in the real business cycle model.
B)the New Keynesian model will produce the same data as the real business cycle model.
C)average labour productivity is countercyclical.
D)employment is constant.
E)employment is countercyclical.