Deck 17: Five Debates Over Macroeconomic Policy

Question 1

Suppose aggregate demand fell. In order to stabilize the economy, what might the government do?

A) increase the interest rate
B) decrease the money supply
C) increase government spending
D) decrease the government expenditures

Answer 1

C

Question 2

What do opponents of using policy to stabilize the economy generally believe?

A) that neither fiscal nor monetary policy have much impact on aggregate demand
B) that attempts to stabilize the economy can increase the magnitude of economic fluctuations
C) that unemployment and inflation are not cause for much concern
D) that unemployment is a cause for concern, but inflation is not

Answer 2

B

Question 3

Why should policymakers try to stabilize the economy?

A) because shocks that cause economic fluctuations are unpredictable
B) because long lags may cause stabilization policies to have an opposite effect
C) because monetary policy affects aggregate demand by changing interest rates
D) because fiscal policy must go through a long political process

Answer 3

C

Question 4

Suppose people in countries that have had persistently high inflation are sceptical about efforts to reduce inflation. What will happen to the short-run Phillips curve and the sacrifice ratio?

A) The short-run Phillips curve remains to the left, and the sacrifice ratio will be low.
B) The short-run Phillips curve remains to the left, and the sacrifice ratio will be high.
C) The short-run Phillips curve remains to the right, and the sacrifice ratio will be low.
D) The short-run Phillips curve remains to the right, and the sacrifice ratio will be high.

Question 5

Which of the following are both policies that are consistent with trying to stabilize output when prices and output rise?

A) decrease the money supply and decrease taxes
B) increase the money supply and decrease taxes
C) decrease the money supply and increase taxes
D) increase the money supply and increase taxes

Question 6

Why should policymakers NOT try to stabilize the economy?

A) Recessions represent a waste of resources.
B) Pessimism on the part of households and firms may become a self-fulfilling prophecy.
C) "Leaning against the wind" requires policymakers to increase aggregate demand in recessions and reduce aggregate demand in booms.
D) Economic conditions can easily change between the time when a policy action begins and when it takes effect.

Question 7

What might offset the effects of a decline in the value of financial assets, such as stocks, on consumption and the economy?

A) increasing government spending
B) decreasing the money supply
C) increasing taxes
D) decreasing the government debt

Question 8

What would those who desire that policymakers stabilize the economy advocate when aggregate demand is insufficient to ensure full employment?

A) decreasing the money supply
B) decreasing taxes
C) decreasing government expenditures
D) decreasing government deficit

Question 9

What will time inconsistency cause?

A) It will cause the short-run Phillips curve to be higher than it otherwise would.
B) It will cause the short-run Phillips curve to be lower than it otherwise would.
C) It will cause the long-run Phillips curve to be farther to the right than it otherwise would.
D) It will cause the long-run Phillips curve to be farther to the left than it otherwise would.

Question 10

If firms were faced with greater uncertainty because of concern that oil prices might rise, they might decrease expenditures on capital. What response might someone who advocated for "lean against the wind" policies support

A) decrease the money supply
B) decrease taxes
C) decrease government expenditures
D) increase interest rates

Question 11

In the aggregate demand and aggregate supply model, which pair of simultaneous events causes a decrease in output and employment?

A) lower demand and lower supply
B) lower demand and higher supply
C) higher demand and higher supply
D) higher demand and lower supply

Question 12

In general, what is the longest lag for fiscal and monetary policy?

A) For both fiscal and monetary policy, it is the time it takes to change policy.
B) For both fiscal and monetary policy, it is the time it takes for policy to affect aggregate demand.
C) For monetary policy, it is the time it takes to change policy, while for fiscal policy the longest lag is the time it takes for policy to affect aggregate demand.
D) For fiscal policy, it is the time it takes to change policy, while for monetary policy the longest lag is the time it takes for policy to affect aggregate demand.

Question 13

What is the main reason that monetary policy has lags?

A) It takes a long time for changes in the interest rate to change aggregate demand.
B) It takes a long time for changes in the money supply to change interest rates.
C) It takes a long time for the Bank of Canada to make changes in policy.
D) It takes a long time for the government to pass the necessary laws.

Question 14

Which of the following best defines the political business cycle?

A) the fact that about every four years some politician advocates greater government control of the Bank of Canada
B) the potential for a central bank to use monetary policy to stimulate the economy and help the incumbent get re-elected
C) the part of the business cycle that reflects reluctance by politicians to smooth out the business cycle
D) the changes in output created by the monetary rule the Bank of Canada must follow

Question 15

Suppose the economy goes into recession. Which of the following is a list of things policymakers could do to try to end the recession?

A) increase the money supply, increase taxes, and increase government spending
B) increase the money supply, increase taxes, and decrease government spending
C) increase the money supply, decrease taxes, and increase government spending
D) decrease the money supply, increase taxes, and decrease government spending

Question 16

How is "leaning against the wind" exemplified?

A) by a tax cut when there is economic expansion
B) by a decrease in the money supply when there is a recession
C) by an increase in government expenditures when there is a recession
D) by an increase in government spending when there is economic expansion

Question 17

What is one reason for the existence of policy lags?

A) Government experts are slow in figuring out what is going on.
B) Households and firms plan their spending in advance and therefore are slow in responding to changes in interest rates.
C) It is impossible to build an accurate model of the economy.
D) It is difficult for the Bank of Canada to change the bank rate in a timely manner.

Question 18

What does the time inconsistency of policy imply?

A) It implies that what policymakers say they will do is generally what they will do, but people don't believe them because of current policy.
B) It implies that when people expect that inflation will be low, it is harder for the Bank of Canada to increase output by increasing the money supply.
C) It implies people always expect more inflation than policymakers claim they are trying to achieve.
D) It implies that the Bank of Canada coordinates its actions with elected officials.

Question 19

What does the time inconsistency of monetary policy mean?

A) It means that once people have formed expectations of low inflation, based on a promise by the central bank, policymakers are tempted to raise inflation in order to lower unemployment and gain favour with voters.
B) It means that sometimes central banks think it is more important to keep unemployment low; at other times, they think it is more important to keep inflation low.
C) It means that monetary policy is not consistent across time because it is influenced by politics.
D) It means that monetary policy cannot be consistent across time because the rate of inflation is fluctuating.

Question 20

The Bank of Canada raised interest rates in 1999 and 2000. By doing this, what did the Bank of Canada do to the money supply and why?

A) It increased the money supply because it was concerned about unemployment.
B) It increased the money supply because it was concerned about inflation.
C) It decreased the money supply because it was concerned about unemployment.
D) It decreased the money supply because it was concerned about inflation.

Question 21

Why should the central bank aim for zero inflation?

A) Reducing inflation imposes temporary costs but provides permanent benefits.
B) Reducing inflation from 2 percent to 0 percent is virtually costless.
C) The government has indexed tax brackets to prevent the adverse effects of inflation.
D) The costs of inflation are very high.

Question 22

In which situation is a program to reduce inflation likely to have the highest costs?

A) if the sacrifice ratio is high and the reduction is unexpected
B) if the sacrifice ratio is high and the reduction is expected
C) if the sacrifice ratio is low and the reduction is unexpected
D) if the sacrifice ratio is low and the reduction is expected

Question 23

How would a permanent reduction in inflation impact menu costs and unemployment?

A) It would permanently reduce menu costs and permanently lower unemployment.
B) It would permanently reduce menu costs and temporarily raise unemployment.
C) It would temporarily reduce menu costs and temporarily lower unemployment.
D) It would temporarily reduce menu costs and temporarily raise unemployment.

Question 24

Why should monetary policy be made by rule rather than discretion?

A) There is a clear consensus among economists about what a good monetary policy rule would be.
B) Rules would eliminate the political business cycle.
C) Rules respond to any random shock in the economy.
D) Rules create time inconsistency.

Question 25

What is a significant cost of inflation?

A) printing more money
B) lower nominal interest rates
C) unintended changes in tax liabilities
D) higher unemployment

Question 26

In which situation does inflation reduction have the lowest cost?

A) when the efforts are credible, so that the sacrifice ratio is low
B) when the efforts are credible, so that the sacrifice ratio is high
C) when the efforts are unexpected, so that the sacrifice ratio is high
D) when the efforts are unexpected, so that the sacrifice ratio is low

Question 27

If a central bank had to give up its discretion and had to follow a rule that required it to keep inflation low, how would the Phillips curve shift?

A) The short-run Phillips curve would shift up.
B) The short-run Phillips curve would shift down.
C) The long-run Phillips curve would shift right.
D) The long-run Phillips curve would shift left.

Question 28

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate demand shifts right, what must the central bank do, and what will happen to output?

A) The central bank must decrease the money supply, which will move output back toward its long-run level.
B) The central bank must decrease the money supply, which will move output farther from its long-run level.
C) The central bank must increase the money supply, which will move output back toward its long-run level.
D) The central bank must increase the money supply, which will move output farther from its long-run level.

Question 29

Proponents of zero inflation argue that reducing inflation involves which of the following?

A) permanent costs and temporary benefits
B) temporary costs and permanent benefits
C) permanent costs and benefits
D) temporary costs and benefits

Question 30

Suppose that a central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate demand shifts right, what should the central bank do, and what will happen to output?

A) The central bank should increase the money supply, which causes output to move closer to its long-run equilibrium.
B) The central bank should increase the money supply, which causes output to move farther from its long-run equilibrium.
C) The central bank should decrease the money supply, which causes output to move closer to its long-run equilibrium.
D) The central bank should decrease the money supply, which causes output to move farther from its long-run equilibrium.

Question 31

Proponents of zero inflation argue that reducing inflation implies which of the following?

A) that reducing inflation eventually reduces inflation expectations
B) that reducing inflation eventually raises real interest rates
C) that reducing inflation permanently decreases output
D) that reducing inflation permanently raises unemployment

Question 32

Why should monetary policy be made by rule rather than discretion?

A) The economy is subject to a variety of random shocks.
B) Monetary policymakers are now allowed undisciplined discretion.
C) It is not clear how important political business cycles have been in the past.
D) Central banks can achieve credibility over time by backing up their words with deeds.

Question 33

Suppose that the central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate supply shifts right, what should the central bank do, and what will happen to output?

A) The central bank should increase the money supply, which causes output to move closer to its long-run equilibrium.
B) The central bank should increase the money supply, which causes output to move farther from its long-run equilibrium.
C) The central bank should decrease the money supply, which causes output to move closer to its long-run equilibrium.
D) The central bank should decrease the money supply, which causes output to move farther from its long-run equilibrium.

Question 34

Some countries have had high inflation for a long time. Others have had low or moderate inflation for a long time. Which statement, at least in theory, could explain why some countries would continue to have high inflation?

A) High-inflation countries have relatively small sacrifice ratios and so see no need to reduce inflation.
B) Inflation reduction works best when it is unexpected, and people in high-inflation countries would quickly anticipate any change in monetary policy.
C) In a country where inflation has been high for a long time, people are likely to have found ways to limit the costs.
D) Persistently low inflation has costs in terms of high unemployment.

Question 35

Why is accountability for monetary policy choices (as opposed to giving policymakers undisciplined discretion) important?

A) Monetary policy has a large and lasting influence on aggregate demand and therefore on employment and income.
B) Elected policymakers can benefit from manipulating monetary policy.
C) Monetary policy announcements will be more credible.
D) Countries with the most independent central banks tend to have the highest rates of inflation.

Question 36

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate supply shifts left, what must the central bank do, and what will happen to output?

A) The central bank must decrease the money supply, which will move output back toward its long-run level.
B) The central bank must decrease the money supply, which will move output farther from its long-run level.
C) The central bank must increase the money supply, which will move output back toward its long-run level.
D) The central bank must increase the money supply, which will move output farther from its long-run level.

Question 37

What could the government do to decrease the costs of inflation without lowering the inflation rate?

A) avoid unexpected changes in the inflation rate
B) rewrite the tax laws so that nominal gains were taxed instead of real gains
C) make policy that would discourage firms from issuing indexed bonds
D) pass legislation to discourage inflation-adjusted work contracts

Question 38

How would a permanent reduction in inflation impact shoe leather costs and unemployment?

A) It would permanently reduce shoe leather costs and permanently lower unemployment.
B) It would permanently reduce shoe leather costs and temporarily raise unemployment.
C) It would temporarily reduce shoe leather costs and temporarily lower unemployment.
D) It would temporarily reduce shoe leather costs and permanently raise unemployment.

Question 39

In which situation is a program to reduce inflation likely to have the lowest costs?

A) if the sacrifice ratio is high and the reduction is unexpected
B) if the sacrifice ratio is high and the reduction is expected
C) if the sacrifice ratio is low and the reduction is unexpected
D) if the sacrifice ratio is low and the reduction is expected

Question 40

Which statement is consistent with the political business cycle theory?

A) The economy expands after the elections.
B) The economy contracts after the elections.
C) The economy expands before the elections.
D) The economy contracts before the elections.

Question 41

Suppose the budget deficit is rising 3 percent per year and nominal GDP is rising 5 percent per year. How are the debt and the burden on future generations created by these continuing deficits?

A) The debt is sustainable, but the future burden on your children cannot be offset.
B) The debt is sustainable, and the future burden on your children can be offset if you save for them.
C) The debt is not sustainable, and the future burden on your children cannot be offset.
D) The debt is not sustainable, but the future burden on your children can be offset if you save for them.

Question 42

Which of the following is a part of the argument against deficits?

A) They increase interest rates and investment.
B) They increase interest rates and decrease investment.
C) They decrease interest rates and investment.
D) They decrease interest rates and increase investment.

Question 43

Suppose that a country has an inflation rate of about 5 percent per year and a real GDP growth rate of about 2 percent per year. What is the highest deficit the government can afford without raising the debt-to-income ratio?

A) about 2 percent of GDP
B) about 7 percent of GDP
C) about 9 percent of GDP
D) about 12 percent of GDP

Question 44

Why should the central bank aim for a moderate rate, instead of a zero rate, of inflation?

A) to keep the natural rate of unemployment low
B) because the social costs of moderate inflation are high
C) because it is very difficult to maintain a zero rate of inflation in the long run
D) the benefits of zero inflation are small but the costs of reaching zero inflation are large.

Question 45

Why are deficits undesirable?

A) They reduce future output.
B) They reduce future consumption.
C) They increase inflation.
D) They increase unemployment.

Question 46

Suppose that at the start of fiscal year 2013 the government had a debt of $6300 billion. Suppose that during fiscal year 2015, real GDP grew by about 4 percent and inflation was about 3 percent. What is the largest deficit the government could have run without raising the debt-to-GDP ratio?

A) about $184 billion
B) about $375 billion
C) about $441 billion
D) about $632 billion

Question 47

Suppose that in fiscal year 2015 the government ran a deficit of about $249 billion. The debt at the start of this period was about $5971 billion. Which of the following combinations of inflation and real GDP would have allowed the government to run a deficit this large without raising the debt-to-income ratio?

A) inflation = 2 percent; real GDP growth = 3 percent
B) inflation = 3 percent; real GDP growth = -1.5 percent
C) inflation = 3 percent; real GDP growth = 1 percent
D) inflation = 1.5 percent; real GDP growth = 1 percent

Question 48

Suppose that at the start of fiscal year 2015 the government had a debt of $6060 billion. Suppose that during the same fiscal year, real GDP grew by about 3 percent and inflation was about 2 percent. What is the largest deficit the government could have run without raising the debt-to-GDP ratio?

A) about $122 billion
B) about $184 billion
C) about $243 billion
D) about $303 billion

Question 49

Suppose that a country has an inflation rate of about 3 percent per year and a real growth rate of about 5 percent per year. Suppose also that it has nominal GDP of about 200 billion units of currency. What is the highest possible deficit it can have without raising the debt-to-income ratio?

A) just under 1 billion units
B) just under 9 billion units
C) just under 12 billion units
D) just under 16 billion units

Question 50

Suppose the budget deficit is rising 2 percent per year and nominal GDP is rising 7 percent per year. Which of the following best describes the debt created by these continuing deficits?

A) sustainable, but the future burden on your children cannot be offset
B) not sustainable, and the future burden on your children cannot be offset
C) not sustainable, but the future burden on your children can be offset if you save for them
D) sustainable, and the future burden on your children can be offset if you save for them

Question 51

Suppose the budget deficit is rising 4 percent per year and nominal GDP is rising 7 percent per year. How are the debt and the burden on future generations created by these continuing deficits?

A) The debt is sustainable, but the future burden on your children cannot be offset.
B) The debt is not sustainable, and the future burden on your children cannot be offset.
C) The debt is sustainable, and the future burden on your children can be offset if you save for them.
D) The debt is not sustainable, but the future burden on your children can be offset if you save for them.

Question 52

Suppose that at the start of fiscal year 2015 the government had a debt of $6220 billion. Suppose that during the same fiscal year, real GDP grew by about 3 percent and inflation was about 1 percent. What is the largest deficit the government could have run without raising the debt-to-GDP ratio?

A) about $122 billion
B) about $184 billion
C) about $249 billion
D) about $375 billion

Question 53

Suppose that a country has an inflation rate of about 3 percent per year and a real growth rate of about 3 percent per year. Suppose also that it has nominal GDP of about 100 billion units of currency. What is the highest deficit it can have without raising the debt-to-income ratio?

A) just under 2 billion units
B) just under 3 billion units
C) just under 5 billion units
D) just under 6 billion units

Question 54

Which of the following would transfer wealth from the young to the old?

A) Taxes are raised to provide better education.
B) Taxes are raised to improve government infrastructure such as roads and bridges.
C) Taxes are raised to provide more generous pensions.
D) Taxes are raised to pay back part of the government debt.

Question 55

If the Canadian government went from a budget deficit to a budget surplus, what would we expect to happen to interest rates and investment?

A) an increase in interest rates and an increase in investment
B) an increase in interest rates and a decrease in investment
C) a decrease in interest rates and a decrease in investment
D) a decrease in interest rates and an increase in investment

Question 56

Suppose the budget deficit is rising 8 percent per year and nominal GDP is rising 10 percent per year. Which of the following best describes the debt created by these deficits?

A) sustainable, but the future burden on your children cannot be offset
B) not sustainable, and the future burden on your children cannot be offset
C) not sustainable, but the future burden on your children can be offset if you save for them
D) sustainable, and the future burden on your children can be offset if you save for them

Question 57

Why should the government balance its budget?

A) because government debt imposes higher taxes or more borrowing on current generations
B) because a balanced budget will smooth the business cycle
C) because moderate budget deficits are unsustainable
D) because recent history shows that the government will not run deficits unless they are justified by war or recession

Question 58

Suppose that a country has an inflation rate of about 3 percent per year and a real growth rate of about 5 percent per year. Suppose also that it has nominal GDP of about 100 billion units of currency. What is the highest deficit it can have without raising the debt-to-income ratio?

A) just under 1 billion units
B) just under 3 billion units
C) just under 6 billion units
D) just under 8 billion units

Question 59

If we calculate the amount of debt, measured in real dollars, what was owed by each Canadian in 2015?

A) $130
B) $1306
C) $13,062
D) $130,620

Question 60

Which of the following would transfer wealth from the old to the young?

A) increases in the budget deficit
B) decreased building of highways and bridges
C) more generous education subsidies
D) indexation of pensions to inflation

Question 61

The laws governing the activity of the Bank of Canada give some specific recommendations about what goals it should pursue, so it has little discretion in making policy.

Question 62

Economists predict the business cycle well enough that stabilization policy is likely to work despite lags in the effects of policy.

Question 63

What would proponents of tax-law changes to encourage saving most likely do?

A) They would argue that corporate tax rates should be increased.
B) They would argue in favour of eliminating or reducing the means tests for government benefits.
C) They would argue that provincial sales tax should be replaced with provincial income tax.
D) They would argue in favour of raising taxes for the wealthy.

Question 64

Assume that the substitution effect is large relative to the income effect. If a tax reform is designed to increase saving, what does it do to the interest rate and spending on capital goods?

A) It increases the interest rate and decreases spending on capital goods.
B) It increases the interest rate and increases spending on capital goods.
C) It decreases the interest rate and increases spending on capital goods.
D) It decreases the interest rate and decreases spending on capital goods.

Question 65

Which statement best describes RRSP plans?

A) They impose added taxes on those who save.
B) They are taxed twice.
C) They postpone income taxes.
D) They are never taxed.

Question 66

Why should the tax laws to encourage saving remain as they are?

A) because a decrease in taxes would primarily benefit the wealthy
B) because tax rates on savings are relatively low
C) because people would probably save more than if taxes were lowered
D) because tax cuts might cause a budget deficit

Question 67

What effects does a higher rate of return have on saving?

A) A higher rate of return has an income effect that discourages saving and a substitution effect that encourages saving.
B) A higher rate of return has an income effect that encourages saving and a substitution effect that discourages saving.
C) A higher rate of return has income and substitution effects that both decrease saving.
D) A higher rate of return has income and substitution effects that both increase saving.

Question 68

What does double taxation mean?

A) Both wage income and interest income are taxed, which is currently the case in Canada.
B) Both wage income and interest income are taxed, which is no longer the case in Canada.
C) Both the profits of corporations and the dividends shareholders receive are taxed, which is no longer the case in Canada.
D) Both the profits of corporations and the dividends shareholders receive are taxed, which is currently the case in Canada.

Question 69

Which tax policy will lead to a tax system with increased equality?

A) increase the limit on retirement savings plans
B) increase the limit on tax-free savings accounts
C) increase the consumption tax
D) reduce taxation of capital income

Question 70

A reduction in the tax rate on income from saving would do which of the following?

A) It would most directly benefit the poor in the short run.
B) It would increase labour productivity over time.
C) It would decrease the capital stock over time.
D) It would decrease real wages over time.

Question 71

Advocates of stabilization policy argue that when there is a recession, the government should increase the money supply and increase government expenditures.

Question 72

Would economists say that, in general, the Canadian tax system encourages saving?

A) Yes, because the taxes on capital gains are low.
B) No, because consumption taxes are generally high.
C) Yes, because some forms of capital gains are not taxed.
D) No, because the taxes on capital gains are high.

Question 73

Why does Canadian public policy discourage saving?

A) because, other things the same, taxes increase the return from savings
B) because means-tested programs such as Old Age Security provide greater benefits to those who saved
C) because some forms of capital income are taxed twice
D) because capital gains are not taxed

Question 74

Which statement is an argument against a tax system that encourages savings?

A) that individuals know better that the government how much to save
B) that saving is not an important determinant of a nation's ability to produce output
C) that rich people would bear the burden of such a tax system
D) that such a tax system would increase inequality

Question 75

Why should the tax laws be reformed to encourage saving?

A) because saving is a key determinant of long-run prosperity
B) because taxes on capital gains are too low
C) because higher-income households are taxed too much
D) because economic theory clearly predicts that a higher rate of return encourages saving

Question 76

In which of the following situations does the government NOT need to balance its budget?

A) if nominal GDP grows faster than the growth in debt
B) if nominal GDP grows slower than the growth in debt
C) if inflation is zero
D) if inflation is higher than the growth in debt

Question 77

If the central bank has discretion to make policy, it may create economic fluctuations that reflect the electoral calendar. This is called the political business cycle.

Question 78

A "lean against the wind" policy says the government should not use stabilization policy and simply let the economy "weather the storm."

Question 79

Why do the five debates over macroeconomic policy exist?

A) mostly because economists disagree over basic issues such as the importance of saving for economic growth
B) mostly because there are tradeoffs and people disagree about the best way to deal with them
C) mostly because economic policies have conflicting effects on various groups of people
D) mostly because people fail to clearly see the benefits or the costs of most changes

Question 80

A recession has no benefit to society-it represents a sheer waste of resources.