Deck 15: Unemployment and Its Natural Rate

Question 1

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

A)monetary and fiscal policies should not be used to "fine tune" the economy.
D)the economy should be stimulated when it is depressed and slowed when it is overheated.
C)the economy should be slowed when it is depressed and stimulated when it is overheated.
D)economists should act to stimulate or slow the economy on the basis of forecasts in order to assure that the policy actions are timely.

Answer 1

A

Question 2

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

A)inside lag of monetary policy.
B)outside lag of monetary policy.
C)inside lag of fiscal policy.
D)outside lag of fiscal policy.

Answer 2

D

Question 3

Increasing government spending when the economy is in a recession is an example of:

A)active monetary policy.
B)active fiscal policy.
C)passive monetary policy.
D)passive fiscal policy.

Answer 3

B

Question 4

Passive economic policy seeks to:

A)offset fluctuations in real GDP.
B)use monetary and fiscal policy to shift aggregate demand.
C)respond to changing economic conditions.
D)take a hands-off approach to macroeconomic policy.

Question 5

Economists who view the economy as inherently unstable generally argue that:

A)stabilization policy is too dangerous to be used.
B)the economy should be stimulated when it is depressed and slowed when it is overheated.
C)the economy should be slowed when it is depressed and stimulated when it is overheated.
D)monetary and fiscal policies should follow rigid rules of constant growth.

Question 6

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:

A)fiscal inside lag.
B)fiscal outside lag.
C)monetary inside lag.
D)monetary outside lag.

Question 7

The time between a shock to the economy and the policy action responding to that shock is called the:

A)automatic stabilizer.
B)time-inconsistency of policy.
C)inside lag.
D)outside lag.

Question 8

The inside lag is the time:

A)before automatic stabilizers respond to economic activity.
B)after automatic stabilizers respond to economic activity.
C)between a shock to the economy and the policy action responding to the shock.
D)between a policy action and its influence on the economy.

Question 9

Arguments in favor of active economic policy include all of the following except:
A)failing to use monetary and fiscal policy leads to inefficient fluctuations in output and employment.
B)the Great Depression could have been avoided if the Federal Reserve had pursued a policy of steady money growth.
C)fluctuations in real GDP have been less severe following World War II than prior to World War I.

A)failure of policymakers to respond to large contractionary shocks to private spending caused the Great Depression.

Question 10

Arguments in favor of passive economic policy include all of the following except:

A)monetary and fiscal policies work with long and variable lags, which can produce destabilizing results.
B)economic forecasts have too large a margin of error to be useful in formulating stabilization policy.
C)recessions do not reduce economic well-being, so using monetary and fiscal policy for stabilization is
D)the Great Depression could have been avoided if the Federal Reserve had pursued a policy of steady money growth.

Question 11

The lags involved in implementing monetary and fiscal policy are:

A)short and predictable.
B)long and predictable.
C)short and variable.
D)long and variable.

Question 12

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

A)preference for using monetary policy rather than fiscal policy for stabilization.
B)view that policy made by rules is superior to policy made by discretion.
C)belief that shocks to modern economies are not large enough to require any policy response.
D)doubt that the correct policy will be implemented at the correct time.

Question 13

Active economic policy seeks to do all of the following except:

A)offset fluctuations in real GDP.
B)use monetary and fiscal policy to shift aggregate demand.
C)respond to changing economic conditions.
D)take a hands-off approach to macroeconomic policy.

Question 14

The time between when a recession begins and when the central bank lowers interest rates to stimulate aggregate demand is an example of an:

A)inside lag of monetary policy.
B)outside lag of monetary policy.
C) inside lag of fiscal policy.
D)outside lag of fiscal policy.

Question 15

Which of the following is an example of a fiscal policy that has no inside lag?

A)a decrease in income tax rates
B)an ongoing unemployment insurance program
C)an increase in government spending for job training
D)a reduction in the age at which people become eligible for retirement benefits

Question 16

The lawmakers who wrote the Employment Act of 1946 believed that:

A)the economy was naturally stable.
B)the Great Depression could not happen again.
C)without active government policy the Great Depression could occur again.
D)monetary policy should be conducted according to rules.

Question 17

All of the following U.S. federal agencies are directly concerned with macroeconomic policy except the:

A)Council of Economic Advisers.
D)Congressional Budget Office.
C)Federal Reserve.
D)Department of Health and Human Services.

Question 18

What are two types of tools that economists use to forecast future economic developments?

A)leading indicators and computer models
B)direct imputations and indirect attributions
C)visual assessment and global positioning
D)monetary instruments and fiscal instruments

Question 19

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

A)active monetary policy.
B)active fiscal policy.
C)passive monetary policy.
D)passive fiscal policy.

Question 20

The outside lag is the time:

A)before automatic stabilizers respond to economic activity.
B)when automatic stabilizers are not effective.
C)between a shock to the economy and the policy action responding to the shock.
D)between a policy action and its influence on the economy.

Question 21

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

A)short and fixed, these policies should not be used to offset shocks.
B)long and variable, these policies should not be used to offset shocks.
C)short and fixed, these policies should be used to offset shocks.
D)long and variable, these policies should be used to offset shocks.

Question 22

Because monetary and fiscal lags are long and variable:

A)stronger policies must be used.
B)successful stabilization policy is completely impossible.
C)attempts to stabilize the economy are often destabilizing.
D)policy must be completely passive.

Question 23

All of the following could be considered automatic stabilizers except:

A)a profit-sharing system for workers.
B)discretionary changes in taxes.
C)a system of unemployment insurance.
D)the federal income tax.

Question 24

The central banks of two nearly identical countries, Fixland and Flexland, desire low inflation and low unemployment. There is a similar short-run tradeoff between unemployment and unexpected inflation in both countries. Private agents in both Fixland and Flexland form expectations rationally and understand the incentives that central banks may have to renege on low-inflation policies. Initially, the rates of inflation and unemployment are the same in both countries. The central bank of Fixland makes a credible announcement that it will operate according to a low-inflation rule. The central bank of Flexland announces that it plans to follow a low-inflation policy, but retains the right to deviate from this policy
at its discretion.
a. In which country would you expect the rate of inflation to be lower?
b. In which country would you expect the unemployment rate to be lower?

Question 25

The Lucas critique argues that because the way people form expectations is based on government policies, economists predict the effect of a change in policy without taking changing expectations into account.

A)partly; cannot
B)only partly; can
C)in no way; can
D)in no way; cannot

Question 26

Assume that the Democrats always had a policy of high money growth whereas the Republicans followed a policy of low money growth, and the economy had a standard Phillips curve. Then, if the two parties took regular terms in office:

A)there would be no political business cycle, but inflation would be higher under the Democrats.
B)there would be no political business cycle, but inflation would be higher under the Republicans.
C)unemployment would be lower under the Democrats but inflation would be higher.
D)both unemployment and inflation would be higher under the Democrats.

Question 27

Let the symbol π stand for the rate of inflation, with πe 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 u = un - α(π - Eπ) applies in a certain economy. The Fed's loss function is L(u, π) = u + γπ2. The analysis in the appendix to textbook Chapter 15 shows that, if the Fed minimizes its loss function under the assumption that Eπ is fixed and
"rational" private agents know this, the expected inflation rate will be Eπ = α/2γ, and this will also be the inflation rate
the government chooses.
a. Suppose that α = 0.5 and γ = 0.05. What are the expected and actual inflation rates?
b.Suppose α = 0.5 and γ = 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 γ = 0.50? Why do they differ from the inflation rates in part a?

Question 28

Assume that in a certain economy the LM curve is given by Y = 2,000r - 2,000 + 2(M/P), and the IS curve is given by Y
= 8,000 - 2,000r + u, where u is a shock that is equal to +200 half the time and -200 half the time. The price level (P) is fixed at 1.0. The natural level 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? What will Y be under rule i when u = -200? b.Under rule ii, what will Y be when u = +200? What will Y be under rule i when u = -200? c.Which rule will keep output closer to 4,000?

Question 29

The long and variable lag before a policy influences the economy makes the job of economic forecasters:

A)impossible.
B)easier.
C)less important.
D)more important.

Question 30

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 level 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?

Question 31

The Phillips curve describing an economy takes the form u = un - α(π - Eπ). The central bank directly sets the inflation
Rate to minimize the following loss function, L(u, π) = u - γπ2. The symbol u denotes the unemployment rate, un is the natural rate of unemployment, π is the inflation rate, Eπ is the expected inflation rate, and α and γ are behavioral response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. In an economy in which the central bank dislikes inflation much more than unemployment:

A)α will be very large.
B)α will be very small.
C)γ will be very large.
D)γ will be very small.

Question 32

The following notice appeared on a full page of the Wall Street Journal on February 9, 2009:
"There is no disagreement that we need action by our government, a recovery plan that will help to jumpstart the economy." -President-elect Barack Obama, January 9, 2009
With all due respect Mr. President, that is not true. Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we the undersigned do not believe that more government spending is a way to improve economic performance. More government spending by Hoover and Roosevelt did not pull the United States out of the Great Depression in the 1930s. More government spending did not solve Japan's "lost decade" in the 1990s. As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today. To improve the economy, policymakers should focus on reforms
that remove impediments to work, saving, investment, and production. Lower tax rates and a
reduction in the burden of government are the best ways of using fiscal policy to boost growth.
The statement was signed by over two hundred economists, including three Nobel Laureates.
a. Comment on the extent to which the disagreement between the president and the economists involves a disagreement about whether policy should be passive or active.
b. Identify the rationale(s) used to support the economists' position.

Question 33

Computer models of the economy:

A)usually consist of only a few equations.
B)require no assumptions about monetary and fiscal policy.
C)require assumptions about monetary and fiscal policy.
D)give excellent predictions regardless of assumptions about monetary and fiscal policy.

Question 34

For each of the following policies indicate whether the policy is i) a monetary or a fiscal policy, ii) an active or a passive policy, and iii) a policy by rules or with discretion:
a. the central bank follows a policy of allowing the money supply to grow at a constant 4 percent per year;
b. a government follows a policy of keeping government spending over a calendar year equal to government revenue over the calendar year;
c. the central bank uses judgment to adjust the growth of the money supply based on expectations of what will happen to output and inflation over the next five years.
d. the government keeps tax laws unchanging and allows government spending to change, depending on which spending bills are passed by the legislature.
e. the central bank follows a policy of adjusting the money supply according to a formula based on deviations of unemployment from the natural rate of unemployment.

Question 35

A central bank operating with discretion can achieve the same outcome as the central bank committed to a fixed rule of zero inflation if:

A)there are no inside lags.
B)there are no outside lags.
C)the central bank dislikes unemployment much more than inflation.
D)the central bank dislikes inflation much more than unemployment.

Question 36

Economic forecasters did:

A)well in forecasting the Great Depression but did poorly in forecasting the recession of 1982.
B)poorly in forecasting both the Great Depression and the recession of 1982.
C)well in forecasting both the Great Depression and the recession of 1982.
D)poorly in forecasting the Great Depression but did well in forecasting the recession of 1982.

Question 37

Policies that stimulate or depress the economy without any deliberate policy change are called:

A)leading indicators.
B)time-inconsistent policies.
C)rational expectations policies.
D)automatic stabilizers.

Question 38

Automatic stabilizers:
C)require congressional action each time before they are put into effect.
B)have no outside lag.
C)have no inside lag.
D)have long and variable inside lags.

Question 39

The Phillips curve describing an economy takes the form u = un - α(π - Eπ). The central bank directly sets the inflation rate to minimize the following loss function, L(u, π) = u - γπ2. The symbol u denotes the unemployment rate, un is the natural rate of unemployment, π is the inflation rate, Eπ is the expected inflation rate, and α and γ 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 .

A)higher; lower
B)higher; the same
C)lower; lower
D)lower; the same

Question 40

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

A)policymaker has and is known to have an extremely strong preference for very low inflation.
B)policymaker does not care about the rate of inflation and simply sets policy to avoid unemployment.
C)private agents in the economy are not "rational."
D)policymaker has more information than do the private agents in the economy.

Question 41

Assume that an economy starts at a long-run equilibrium with a natural rate of unemployment equal to 6 percent and an inflation rate of 10 percent. Assume that there is a short-run tradeoff between inflation and unemployment as described by a Phillips curve. Use the Phillips curve to graphically illustrate why a central bank that desires both low inflation and low unemployment has the incentive to renege on an announced policy to reduce inflation to 3 percent, if people set wages and prices on the expectation of 3 percent inflation and the central bank has the discretion to change its monetary policy after these expectations are set.

Question 42

Explain why each of the following statements is a rationale for conducting active or passive policy:
a. Economic circumstances can change dramatically between the time that an economic downturn begins and the time when policy actions have an effect on the economy.
b. Economists are not very accurate forecasters.
c. Increases in government spending generate increases in economic output. d. Fluctuations in economic output have been less severe since World War II.