Deck 14: Stabilizing the Economy: the Role of the Fed

Question 1

Starting from full employment at the initial target inflation rate, if there is an adverse inflation shock, then the Federal Reserve must _____ in order to keep inflation at the initial target level.

A) increase the target inflation rate.
B) decrease the target inflation rate.
C) maintain the initial target inflation rate.
D) shift the short-run aggregate supply curve up.

Answer 1

C

Question 2

Following an adverse inflation shock the economy will return to potential more rapidly if:

A) inflationary expectations are anchored.
B) inflationary expectations change quickly in response to the shock.
C) the Fed has frequently accommodated higher inflation in the past.
D) the Fed has frequently raised its target inflation rate in the past.

Answer 2

A

Question 3

Policymakers' use of stabilization policy to eliminate output gaps is more appropriate when an economy self corrects very ______ and when the output gap is very ____.

A) rapidly; large
B) rapidly; small
C) slowly; small
D) slowly; large

Answer 3

D

Question 4

The second round increase in inflation following an adverse supply shock is the result of:

A) shifts in potential output.
B) increases in the Federal Reserve's target real interest rate.
C) decreases in the Federal Reserve's target real interest rate.
D) increases in long-term inflationary expectations.

Question 5

Reduced macroeconomic variability in the U.S. since the 1981 has all of the following benefits EXCEPT:

A) improving market functioning.
B) making business planning easier.
C) reducing resources devoted to managing inflation risks.
D) allowing the Fed to pursue accommodating policy.

Question 6

Shocks to aggregate demand ______ require the Fed to choose between inflation and output stability; shocks to aggregate supply ______ require the Fed to choose between inflation and output stability.

A) do; do
B) do; do not
C) may or may not; may or may not
D) do not; do

Question 7

Shocks to _____ require the Fed to choose between inflation and output stability, while shocks to _____ do not require the Fed to choose between inflation and output stability.

A) the stock market; aggregate demand
B) the stock market; aggregate supply
C) aggregate demand; aggregate supply
D) aggregate supply; aggregate demand

Question 8

Most economists believe that the reduced variability of inflation in the U.S. is the result of:

A) globalization.
B) better management of inventories.
C) improved monetary policymaking by the Fed.
D) deregulation.

Question 9

Starting from full employment at the initial target inflation rate, if there is an adverse inflation shock, then the Federal Reserve must _____ in order to keep inflation from becoming permanently higher.

A) increase the target inflation rate.
B) decrease the target inflation rate.
C) maintain the initial target inflation rate.
D) shift the short-run aggregate supply curve up.

Question 10

To prevent inflation from becoming permanently higher following an adverse inflation shock the Fed must ____, while to offset the effect of an increase in aggregate demand the Fed must _____.

A) lower the inflation rate target; adjust the real interest rate target to the level at which saving equals investment in the long run.
B) raise the inflation rate target; adjust the real interest rate target to the level at which saving equals investment in the long run.
C) maintain the inflation rate target; maintain the real interest rate target.
D) maintain the inflation rate target; adjust the real interest rate target to the level at which saving equals investment in the long run.

Question 11

Shocks to aggregate demand _____ require the Fed to choose between inflation and output stability, while shocks to aggregate supply ____ require the Fed to choose between inflation and output stability.

A) do; do
B) do; do not
C) may or may not; may or may not
D) do not; do

Question 12

Anchored inflationary expectations are beneficial to an economy because they:

A) reduce the inside lag of macroeconomic policymaking.
B) rapidly shift the central bank's monetary policy reaction function.
C) shorten recessions caused by adverse inflation shocks.
D) eliminate any changes in short-run aggregate supply.

Question 13

Anchored inflationary expectations are people's expectations of future inflation that:

A) increase if inflation rises temporarily.
B) are based on the unemployment rate.
C) do not change if inflation rises temporarily.
D) are based on the level of potential output.

Question 14

People's expectations of future inflation that do not change even if inflation rises temporarily are called _____ inflationary expectations.

A) aggregate
B) average
C) anchored
D) autonomous

Question 15

Starting from full employment at the initial target inflation rate, if there is an adverse inflation shock, then the Federal Reserve must _____ in order to avoid a recession.

A) increase the target inflation rate.
B) decrease the target inflation rate.
C) maintain the initial target inflation rate.
D) shift the short-run aggregate supply curve up.

Question 16

Following an adverse supply shock, people with anchored inflation expectations believe the Fed will:

A) raise it target inflation rate.
B) lower its target inflation rate.
C) keep its target inflation rate unchanged.
D) accommodate the shock.

Question 17

To accommodate an adverse inflation shock the Fed must ____, while to offset the effect of an increase in aggregate demand the Fed must _____.

A) lower the inflation rate target; adjust the real interest rate target to the level at which saving equals investment in the long run.
B) raise the inflation rate target; adjust the real interest rate target to the level at which saving equals investment in the long run.
C) maintain the inflation rate target; maintain the real interest rate target.
D) adjust the real interest rate target to the level at which saving equals investment in the long run; lower the inflation rate target.

Question 18

The credibility of monetary policy is the:

A) recognition that open market purchases increase the money supply, even though banks and the public affect the money multiplier.
B) degree to which the public believes the central bank's promises to keep inflation low, even if doing so may impose short-run costs.
C) pace at which monetary policy can return an economy to potential when inflationary expectations are anchored.
D) practice of the Federal Reserve of relying primarily on open market operations rather than discount rate lending or changes in reserve requirements.

Question 19

Starting from full employment at the initial target inflation rate, if there is a favorable inflation shock, then the Federal Reserve must _____ in order to return output to potential.

A) increase the target inflation rate.
B) decrease the target inflation rate.
C) maintain the initial target inflation rate.
D) shift the short-run aggregate supply curve up.

Question 20

The speed at which an economy returns to potential following an adverse inflation shock depends on:

A) the Federal Reserve's target inflation rate.
B) the Federal Reserve's target real interest rate.
C) the level of potential output.
D) the public's expectations of how the Federal Reserve will act.

Question 21

Which of the following characteristics of a central bank is expected to enhance monetary policy credibility?

A) the central bankers short terms that coincide with the terms of the legislature.
B) daily central bank actions are subject to the review and veto of the executive branch of the government.
C) the central bank announces a numerical inflation target.
D) the central bank is under the obligation to finance the national deficit.

Question 22

The situation in which central bankers are insulated from short-term political considerations and are allowed to take a long-term view of the economy is called:

A) being an inflation dove.
B) being an inflation hawk.
C) central bank independence.
D) the inside lag of monetary policy.

Question 23

If inflation equals zero, then a worker's real wage will fall when:

A) the nominal wage increases by less than 1% per year.
B) the nominal wage decreases.
C) the nominal wage is constant.
D) relative prices increase.

Question 24

The degree to which the public believes the central bank's promises to keep inflation low, even if doing so may impose short-run economic costs is the _____ of monetary policy.

A) power
B) opportunity cost
C) credibility
D) expectation

Question 25

The greater the credibility of monetary policy the ____ likely inflationary expectations are to be anchored and the _____ the recessions caused by adverse inflation shocks.

A) more; shorter
B) more; longer
C) less; shorter
D) less; longer

Question 26

All of the following central banks have announced numerical targets for inflation EXCEPT the:

A) United States Federal Reserve System.
B) Bank of Canada.
C) Bank of England.
D) Central Bank of Brazil.

Question 27

Central bank independence refers to situations in which central bankers:

A) conduct open market operations in free markets.
B) operate in countries with independently elected governments.
C) are insulated from short-term political considerations.
D) are appointed without confirmation hearings.

Question 28

All of the following are examples of the independence of the U.S. Federal Reserve System EXCEPT that:

A) the Federal Reserve Act does not explicitly prohibit legislative interference in monetary policy.
B) Federal Reserve Governors are appointed for 14-year terms.
C) the Federal Reserve controls its own budget.
D) the Federal Reserve is under no obligation to finance the national deficit.

Question 29

Central banks that practice flexible inflation targeting are ____ than central banks that practice strict inflation targeting.

A) more likely to adjust policy in response to output gaps
B) less likely to adjust policy in response to output gaps
C) more concerned with inside lags in macroeconomic policy
D) less concerned with inside lags macroeconomic policy

Question 30

A central bank that attempts to achieve a zero rate of inflation:

A) cannot achieve price level stability in the long run.
B) increases the risk of deflation.
C) can consistently achieve negative real interest rates.
D) makes it easier for real wages to be reduced without cutting nominal wages.

Question 31

Which of the following statements about inflation targeting is true?

A) Inflation targets have only been used in developed countries.
B) Inflation targets are always met.
C) Inflation targets have been used in both developed and developing countries.
D) Inflation targets increase uncertainty.

Question 32

All of the following are characteristics of independent central banks EXCEPT:

A) long terms for central bankers.
B) no obligation to finance the national deficit.
C) budgetary independence.
D) ability of executive branch to overrule central bank actions.

Question 33

Announced numerical inflation targets are advocated for all of the following reasons EXCEPT that inflation targets:

A) reduce inflation uncertainty.
B) anchor inflationary expectations.
C) enhance central bank credibility.
D) eliminate the tradeoff between maintaining output or inflation in the event of adverse inflationary shocks.

Question 34

The Fed cannot achieve a negative real interest rate if the inflation rate is zero or negative because:

A) the nominal interest rate cannot fall below zero.
B) inflation doves will not permit a negative real interest rate.
C) zero or negative values of inflation cannot be accurately measured.
D) inflationary expectations are not anchored when the inflation rate is zero.

Question 35

If the rate of inflation equals zero then the nominal rate of interest:

A) equals zero.
B) equals the real rate of interest.
C) can be negative.
D) equals the target real interest rate.

Question 36

All of the following are reasonable arguments against adopting a zero inflation target EXCEPT that a zero inflation target:

A) makes the undesirable effects of deflation more likely.
B) prevents the central bank from achieving a negative real interest rate.
C) is not consistent with long-run price stability.
D) based on the CPI would not generate "true" price stability because of CPI measurement problems.

Question 37

If the rate of inflation equals zero then the real rate of interest:

A) equals zero.
B) equals the nominal rate of interest.
C) can be negative.
D) equals the target real interest rate.

Question 38

An argument against a central bank policy of announcing numerical inflation targets is that inflation targeting policies:

A) enhance central bank credibility.
B) anchor inflationary expectations.
C) emphasize inflation at the expense of output stabilization.
D) increase uncertainty.

Question 39

Which of the following policies is likely to enhance a central bank's credibility?

A) announce inflation targets.
B) appoint inflation doves as central bankers.
C) make the central bank obligated to finance the national deficit.
D) appoint central bankers for short terms that coincide with those in the legislative and executive branches of government.

Question 40

All of the following are ways to enhance central bank credibility EXCEPT to:

A) announce inflation targets.
B) appoint inflation hawks as central bankers.
C) put no obligation on the central bank to finance the national deficit.
D) make central bank actions subject to frequent review and veto by the executive and legislative branches of government.

Question 41

A tax increase that affects both aggregate demand and potential output is predicted to _____ the long-run equilibrium level of output, while inflation _____.

A) decrease; increases
B) increase; decreases
C) decrease; may increase, decrease, or remain unchanged
D) decrease; decrease

Question 42

Suppose last year Moe faced a 25% marginal tax rate. This year tax rates increased and now Moe faces a 30% marginal tax rate. Moe chooses to work more hours this year because

A) working hours tend to increase over a worker's life in the U.S.
B) the opportunity cost of leisure - not working - has increased.
C) the opportunity cost of leisure - not working - has fallen.
D) Moe must work more hours to have the same after-tax income this year.

Question 43

An inflation _____ may be more likely to stabilize output as well as inflation because they have established credibility and _____.

A) dove; lowered the core rate of inflation.
B) hawk; reduced inside lags.
C) dove: anchored inflationary expectations.
D) hawk; anchored inflationary expectations.

Question 44

Total taxes paid divided by total before-tax income is called the:

A) average tax rate.
B) substitution effect.
C) opportunity cost.
D) marginal tax rate.

Question 45

Someone who is not strongly committed to achieving and maintaining low inflation is called a(n):

A) anchored central banker.
B) inflation dove.
C) inflationary central banker.
D) inflation hawk.

Question 46

The marginal tax rate is:

A) total taxes divided by total before-tax income.
B) the average tax rate divided by the total tax rate.
C) the amount by which taxes increase when before-tax income rises by an additional dollar.
D) the tax rate at which the benefit of an extra dollar of taxes equals the cost of an extra dollar of taxes.

Question 47

The amount by which taxes increase when before-tax income rises by an additional dollar is called the:

A) average tax rate.
B) substitution effect.
C) opportunity cost.
D) marginal tax rate.

Question 48

A tax cut that affects both aggregate demand and potential output is predicted to _____ the long-run equilibrium level of output, while inflation _____.

A) increase; increases
B) increase; decreases
C) increase; may increase, decrease, or remain unchanged
D) decrease; decrease

Question 49

Someone who is committed to maintaining low inflation even at the short-run cost of reduced output and employment is called a(n):

A) anchored central banker.
B) reactionary central banker.
C) inflation dove.
D) inflation hawk.

Question 50

Real wages can be cut without cutting nominal wages if:

A) the rate of inflation is positive.
B) the rate of inflation is zero.
C) the rate of inflation is negative.
D) there is deflation.

Question 51

An inflation dove is someone who

A) easily anchors inflation expectations.
B) is not strongly committed to maintaining low inflation.
C) is committed to maintaining low inflation even at the cost of reduced output and employment.
D) believes monetary policy is more powerful than fiscal policy.

Question 52

Lower taxes on interest income

A) permanently lower growth rates by encouraging saving rather than consuming.
B) increase growth rates by increasing consumption rates.
C) increase growth rates by increasing saving and thus investment.
D) lower growth rates by reducing government expenditures.

Question 53

Fiscal policy includes

A) tax policy only.
B) government expenditures only.
C) tax policy and government expenditures.
D) tax policy, government expenditures, and monetary policy.

Question 54

Suppose last year Moe faced a 25% marginal tax rate. This year tax rates increased and now Moe faces a 30% marginal tax rate. Moe chooses to work fewer hours this year because

A) working hours tend to increase over a worker's life in the U.S.
B) the opportunity cost of leisure - not working - has increased.
C) the opportunity cost of leisure - not working - has fallen.
D) Moe must work more hours to have the same after-tax income this year.

Question 55

An inflation hawk is someone who:

A) puts equal weight on maintaining output at potential and keeping prices stable.
B) is committed to maintaining low inflation even at the cost of reduced output and employment.
C) is committed to maintaining output at potential even at the cost of high inflation.
D) encourages policy accommodation.

Question 56

A supply-side policy is a policy that

A) shifts the short-run aggregate supply curve.
B) shifts the long-run aggregate supply curve.
C) shifts the aggregated demand curve.
D) prevents recessionary gaps that shift the AS curve.

Question 57

The average tax rate is:

A) total taxes divided by total before-tax income.
B) the average tax rate divided by the total tax rate.
C) the amount by which taxes increase when before-tax income rises by an additional dollar.
D) the tax rate at which the benefit of an extra dollar of taxes equals the cost of an extra dollar of taxes.

Question 58

By changing the incentives, reductions in marginal tax rates can increase potential output in each of the following ways EXCEPT by encouraging households to:

A) enjoy more hours of leisure.
B) work more hours.
C) take more entrepreneurial risk.
D) invest in more human capital.

Question 59

Fiscal policy can shift

A) aggregate demand only.
B) both aggregate demand and potential output.
C) both aggregate demand and short-run aggregate supply, but not long-run aggregate supply.
D) only short-run functions.

Question 60

An increase in marginal tax rates

A) increases a worker's hourly after-tax wage.
B) increases the opportunity cost of leisure (not working).
C) reduces the opportunity cost of leisure (not working).
D) increases incentives to work more.

Question 61

The delay between the date a policy change is implemented and the date when most of its effects have occurred in the economy is called the:

A) recessionary gap.
B) expansionary gap.
C) outside lag.
D) inside lag.

Question 62

The time between when the fed funds rate is cut and investment spending increases is an example of:

A) Okun's law.
B) the outside lag in macroeconomic policy.
C) anchoring inflationary expectations.
D) the inside lag in macroeconomic policy.

Question 63

All of the following tend to make economic policymaking difficult and inexact EXCEPT the:

A) lack of precise knowledge about the state of the economy.
B) inability to develop statistical models of the economy.
C) lack of knowledge about the future course of the economy if no policy changes are implemented.
D) imprecise knowledge of the level of potential output.

Question 64

The inside lag of macroeconomic policy is the:

A) time between a shift in aggregate demand and a shift in aggregate supply.
B) delay between when a policy change is needed and the policy is implemented.
C) difference between actual inflation and the target rate of inflation.
D) delay between when a policy change is implemented and when most of the effects of policy have occurred in the economy.

Question 65

If the professional opinions of economists regarding the natural rate of unemployment vary between 4.5 and 6 percent, then when the actual rate of unemployment equals 5 percent:

A) the natural rate of unemployment equals 5 percent.
B) there is a recessionary gap.
C) there is an expansionary gap.
D) there could be either an expansionary or recessionary gap, or the economy could be at potential depending on the accuracy of measurement.

Question 66

The delay between the date a policy change is needed and the date it is implemented is called the:

A) recessionary gap.
B) expansionary gap.
C) outside lag.
D) inside lag.

Question 67

The outside lag of macroeconomic policy is the:

A) time between a shift in aggregate demand and a shift in aggregate supply.
B) delay between when a policy change is needed and the policy is implemented.
C) difference between actual inflation and the target rate of inflation.
D) delay between when a policy change is implemented and when most of the effects of policy have occurred in the economy.

Question 68

The inside lag is relatively shorter for _____ policy and the outside lag is relatively shorter for _____ policy.

A) monetary; fiscal
B) monetary; monetary
C) fiscal; monetary
D) fiscal; fiscal

Question 69

Evidence from work hours and marginal tax rates in different countries suggests that

A) higher marginal tax rates encourage more work hours.
B) lower marginal tax rates encourage more work hours.
C) marginal tax rates are not related to work hours.
D) higher average tax rates encourage more work hours.

Question 70

The time between when income taxes are cut and consumption spending increases is an example of:

A) the outside lag in macroeconomic policy.
B) the inside lag in macroeconomic policy.
C) the outside lag in fiscal policy.
D) the inside lag in fiscal policy.

Question 71

A reduction in the marginal tax rate can cause potential output to increase by

A) encouraging early entry into the labor market by reducing the incentive to earn advanced degrees.
B) increasing after-tax wage rates and thus allowing workers to work fewer hours.
C) increasing the incentive to invest more in education and earn advanced degrees.
D) increasing government revenues and thus government expenditure.

Question 72

Relative to workers in Western Europe, workers in the U.S.

A) face a lower marginal tax rate and work fewer hours per year.
B) face a higher marginal tax rate and work more hours per year.
C) face a lower marginal tax rate and work more hours per year.
D) face a higher marginal tax rate and work fewer hours per year.

Question 73

If the professional opinions of economists regarding the natural rate of unemployment vary between 4.5 and 6 percent, then when the actual rate of unemployment equals 10.5 percent:

A) the natural rate of unemployment equals 10.5 percent.
B) there is a probably recessionary gap.
C) there is probably an expansionary gap.
D) the economy is probably at potential output.

Question 74

The time between when Congress decides to cut taxes to stimulate aggregate demand and when the tax cuts are implemented is an example of:

A) the outside lag in macroeconomic policy.
B) the inside lag in macroeconomic policy.
C) the outside lag in fiscal policy.
D) the inside lag in fiscal policy.

Question 75

The time between when Federal Reserve policymakers decide to close an output gap and when they act to change the fed funds rate is an example of:

A) the outside lag in macroeconomic policy.
B) a structural policy change.
C) anchoring inflationary expectations.
D) the inside lag in macroeconomic policy.