Deck 18: Alternative Perspectives on Stabilization Policy

Question 1

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.

Answer 1

doubt that the correct policy will be implemented at the correct time.

Question 2

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.

Answer 2

fiscal inside lag.

Question 3

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.

Answer 3

without active government policy the Great Depression could occur again.

Question 4

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 5

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 6

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

Question 7

Fiscal policy has a relatively long ______ lag, and monetary policy has a relatively long ______ lag.

A) inside; outside
B) outside; inside
C) inside; inside
D) outside; outside

Question 8

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 9

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 10

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 11

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.
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) economists should act to stimulate or slow the economy on the basis of forecasts in order to assure that the policy actions are timely.

Question 12

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 13

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 unnecessary.
D) the Great Depression could have been avoided if the Federal Reserve had pursued a policy of steady money growth.

Question 14

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

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

Question 15

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 16

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 17

The time between a policy action and its influence on the economy is called the:

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

Question 18

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 19

The lag between the time that the money supply is increased and the time that investment expenditures increase is an example of a:

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

Question 20

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.

Question 21

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 22

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.

Question 23

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 24

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 25

The fact that traditional methods of policy evaluation do not take into account the impact of policy on expectations is known as:

A) stabilization policy.
B) the political business cycle.
C) the Lucas critique.
D) Okun's law.

Question 26

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 27

According to Christina Romer, the reduction in real economic volatility in the period since World War II compared to the period before World War I is the result of improved economic:

A) policy.
B) performance.
C) data.
D) forecasting.

Question 28

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 29

The differing interpretations of the historical record of the Great Depression provide support for using:

A) active macroeconomic policy only.
B) passive macroeconomic policy only.
C) either active or passive macroeconomic policy.
D) neither active nor passive macroeconomic policy.

Question 30

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 31

If past economic fluctuations resulted from inept economic policies, then the historical evidence would support using:

A) active macroeconomic policy only.
B) passive macroeconomic policy only.
C) either active or passive macroeconomic policy.
D) neither active nor passive macroeconomic policy.

Question 32

All of the following could be considered automatic stabilizers except:

A) transfer payments that increase during recessions.
B) discretionary changes in taxes.
C) a system of unemployment insurance.
D) the federal income tax.

Question 33

If people's expectations of inflation are formed rationally rather than based on adaptive expectations and if policymakers make a credible policy move to reduce inflation, then the costs of reducing inflation will be ______ traditional estimates of the sacrifice ratio.

A) much higher than
B) much lower than
C) exactly equal to
D) approximately two percent greater than

Question 34

Policy is conducted by rule if policymakers:

A) announce in advance how policy will respond to various situations and commit themselves to following through on this announcement.
B) are free to size up the situation case by case and choose whatever policy seems appropriate at the time.
C) set policy according to election results, i.e., set policy by rule of the ballot box.
D) manipulate policy to ensure both low inflation and unemployment on election day.

Question 35

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 36

If past policies kept the economy insulated from shocks to aggregate demand and supply, the historical evidence would support using:

A) active macroeconomic policy only.
B) passive macroeconomic policy only.
C) either active or passive macroeconomic policy.
D) neither active nor passive macroeconomic policy.

Question 37

Automatic stabilizers:

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

Question 38

According to advocates of rational expectations, traditional estimates of the sacrifice ratio are unreliable because they:

A) ignore inside lags.
B) overestimate outside lags.
C) are based on adaptive expectations.
D) are time inconsistent.

Question 39

According to the Lucas critique, when economists evaluate alternative policies they must take into consideration:

A) how the policies will affect expectations and behavior.
B) whether the policy will offset the impact of automatic stabilizers.
C) the stage of the political business cycle in which the policy is to be implemented.
D) the length of the inside lags associated with the policies.

Question 40

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 41

The political business cycle refers to the:

A) pattern of holding primaries, conventions, and general elections every four years.
B) cycle of electing U.S. representatives every two years, the U.S. president every four years, and U.S. senators every six years.
C) manipulation of the economy to win elections.
D) pattern of recession and expansion that follows every election.

Question 42

If citizens vote on the basis of both low inflation and low unemployment at the time of the election, then presidents might, in order to ensure their reelection:

A) spur inflation soon after their elections, and then cause a recession.
B) stimulate the economy throughout their terms.
C) cause a recession soon after their election, and then stimulate the economy.
D) run a tight monetary and fiscal policy throughout their terms.

Question 43

An argument in favor of allowing discretionary macroeconomic policy is that:

A) policymakers may make erratic shifts in policy in response to changing political situations.
B) uninformed policymakers may choose incorrect policies.
C) the objectives of policymakers may be in conflict with the well-being of the public.
D) giving policymakers flexibility will allow them to respond to changing conditions.

Question 44

If policymakers are free to analyze events as they occur and choose whatever policy seems appropriate at the time, then this is:

A) policy by rule.
B) policy by discretion.
C) monetary policy.
D) fiscal policy.

Question 45

A situation where policymakers have the incentive to deviate from their initial course of action once other agents in the economy have acted is called a(n):

A) rational expectation.
B) outside lag.
C) time-inconsistent policy.
D) active policy rule.

Question 46

As Secretary of the Treasury, Alexander Hamilton opposed the time-inconsistent policy of:

A) repaying the debt.
B) raising taxes.
C) repudiating the debt.
D) reducing taxes.

Question 47

Conducting monetary policy so that the FF rate = 0.05, where the FF rate is the nominal federal funds interest rate, is an example of :

A) an active policy rule.
B) a passive policy rule.
C) discretionary policy.
D) an automatic stabilizer.

Question 48

Assume that there is a short-run tradeoff between inflation and unemployment, that the central bank desires both low inflation and low unemployment, and that the central bank uses discretion in conducting monetary policy. Initially, households and firms expect high inflation. Following an announcement by the central bank of a low-inflation policy, households and firms will ______ the central bank's announcement and ______ their expectations of inflation.

A) believe; lower
B) not believe; not change
C) believe; not change
D) not believe; lower

Question 49

If the Fed has discretion to choose its own policy and announces a policy of low inflation, then:

A) the policymaker is required to make the money supply grow at a low rate.
B) private economic agents are sure to believe the announcement because it is credible.
C) private economic actors are likely to discount the policy because the Fed has an incentive to renege on its policy once expectations are formed.
D) the Fed is certain to renege on its policy once expectations are formed because then it can lower unemployment with minimum inflation.

Question 50

Conducting fiscal policy so that G = T, where G is government expenditures and T is tax revenue, is an example of a(n):

A) active rule.
B) passive rule.
C) discretionary policy.
D) automatic stabilizer.

Question 51

The manipulation of the economy to win elections is called:

A) discretionary monetary policy.
B) discretionary fiscal policy.
C) the political business cycle.
D) an automatic stabilizer.

Question 52

If policymakers announce in advance how policy will respond to various situations and commit themselves to following through on this announcement, this is:

A) policy by rule.
B) policy by discretion.
C) time inconsistent policy.
D) monetary policy.

Question 53

Policy is conducted by discretion if policymakers:

A) announce in advance how policy will respond to various situations and commit themselves to following through on this announcement.
B) are free to size up the situation case by case and choose whatever policy seems appropriate at the time.
C) announce and maintain a constant growth rate of the money supply.
D) announce and achieve a balanced government budget.

Question 54

Conducting fiscal policy so that G = T + $\beta$ (u - u_n), where G is government expenditures, T is tax revenue, u is the unemployment rate, u_n is the natural rate of unemployment, and $\beta$ is a positive number, is an example of a(n):

A) active rule.
B) passive rule.
C) discretionary policy.
D) automatic stabilizer.

Question 55

A time-inconsistency problem in macroeconomic policy can occur when the policymaker:

A) is made to follow a strict and an inflexible rule.
B) has discretion in the short run but follows a rule in the long run.
C) has discretion to act as it seems best in each situation, based on his or her own knowledge and experience.
D) has no discretion.

Question 56

Policymakers may be better able to achieve their goals using a fixed policy rule rather than using discretion if they face the problem of:

A) short and predictable inside lags.
B) time-inconsistent policy.
C) short and predictable outside lags.
D) weak automatic stabilizers.

Question 57

When a government honors its debt obligations, this is an example of:

A) discretionary fiscal policy.
B) discretionary monetary policy.
C) a fiscal policy rule.
D) a monetary policy rule.

Question 58

Assume that there is a short-run tradeoff between inflation and unemployment, that the central bank desires both low inflation and low unemployment, and that the central bank follows a fixed rule in conducting monetary policy. Initially, households and firms expect high inflation. Following a credible announcement by the central bank of a low-inflation policy, households and firms will ______ the central bank's announcement and ______ their expectations of inflation.

A) believe; lower
B) not believe; not change
C) believe; not change
D) not believe; lower

Question 59

Conducting monetary policy so that the FF rate = $\pi$ + 0.5( $\pi$ - 2) + 0.5 (GDP gap), where the FF rate is the nominal federal funds interest rate, $\pi$ is the annual inflation rate, and GDP gap is the percentage shortfall of real GDP from its natural level, is an example of :

A) an active policy rule.
B) a passive policy rule.
C) discretionary policy.
D) an automatic stabilizer.

Question 60

A policy rule:

A) must specify money growth at a constant rate.
B) must specify an active policy.
C) must specify a passive policy.
D) may specify either an active or a passive policy.

Question 61

The Phillips curve describing an economy takes the form u = uⁿ - $\alpha$ ( $\pi$ - E $\pi$ ). The central bank directly sets the inflation rate to minimize the following loss function, L(u, $\pi$ ) = u + $\gamma$ $\pi$ ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, $\pi$ is the inflation rate, E $\pi$ is the expected inflation rate, and $\alpha$ and $\gamma$ 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 62

The Phillips curve describing an economy takes the form u = uⁿ - $\alpha$ ( $\pi$ - E $\pi$ ). The central bank directly sets the inflation rate to minimize the following loss function, L(u, $\pi$ ) = u + $\gamma$ $\pi$ ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, $\pi$ is the inflation rate, E $\pi$ is the expected inflation rate, and $\alpha$ and $\gamma$ are behavioral response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. The optimal inflation rate when the central bank operates using a fixed rule will be ______. The optimal inflation rate when the central bank operates with discretion will be ______.

A) uⁿ; 0
B) 0; uⁿ
C) 0; $\alpha$ /(2 $\gamma$ )
D) $\alpha$ /(2 $\gamma$ ); 0

Question 63

Economic science has provided convincing evidence in favor of the:

A) rule favoring a constant rate of growth of the money supply.
B) rule favoring use of the money supply to hit a nominal GDP target.
C) rule requiring a constantly balanced budget for the federal government.
D) fact that there is no simple and compelling case for any particular view of macroeconomic policy.

Question 64

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 65

Monetary policy rules that target nominal variables would target any of the following except the:

A) price level.
B) money supply
C) unemployment rate.
D) level of nominal GDP.

Question 66

The Phillips curve describing an economy takes the form u = uⁿ - $\alpha$ ( $\pi$ - E $\pi$ ). The central bank directly sets the inflation rate to minimize the following loss function, L(u, $\pi$ ) = u + $\gamma$ $\pi$ ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, $\pi$ is the inflation rate, E $\pi$ is the expected inflation rate, and $\alpha$ and $\gamma$ 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) $\alpha$ will be very large.
B) $\alpha$ will be very small.
C) $\gamma$ will be very large.
D) $\gamma$ will be very small.

Question 67

Although real variables such as unemployment and real GDP are the best measures of economic performance, most economists do not advocate manipulating money supply directly to hit a real target because:

A) they believe a constant growth rate of the money supply is the best way to stabilize real GDP or unemployment.
B) if the Fed chose a target that was not natural output or the natural unemployment rate, the result would be accelerating inflation or deflation.
C) if the Fed chose a target for the unemployment rate above the natural rate, the result would be accelerating inflation.
D) if the Fed chose a target for the unemployment rate below the natural rate, the result would be accelerating deflation.

Question 68

Assume that the Democrats always had a policy of high money growth while 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 69

Countries with greater central-bank independence can achieve lower rates of inflation:

A) at the cost of higher levels of unemployment.
B) at the cost of slower growth rates of real GDP.
C) at the cost of greater volatility of real GDP.
D) with no apparent real economic costs.

Question 70

Unlike a monetarist policy rule, an inflation target has the advantage of:

A) eliminating the need to announce the policy target.
B) providing a real target rather than a nominal one.
C) allowing the central bank unlimited discretion.
D) insulating the economy from changes in money velocity.

Question 71

Central-bank independence refers to:

A) whether central banks pursue monetary policy by rules or discretion.
B) the situation that occurs when the inside lag of monetary policy is not related to the outside lag.
C) the extent to which automatic stabilizers are relied on to cushion economic volatility.
D) the degree of separation between central-bank decision making and political influence.

Question 72

Inflation targeting is a monetary policy rule that requires the central bank to adjust _____ in order to attain the desired inflation rate.

A) a price index
B) the velocity of money
C) nominal GDP
D) the money supply

Question 73

If the velocity of money varies a great deal, steady growth of the money supply is a(n):

A) ineffective way to stabilize aggregate demand.
B) example of discretionary monetary policy.
C) automatic stabilizer.
D) active policy rule.

Question 74

Monetarists believe all of the following except:

A) fluctuations in the money supply are responsible for most large fluctuations in the economy.
B) the Fed should keep the money supply growing at a steady rate.
C) slow and steady growth of the money supply would yield stable output, employment, and prices.
D) the Fed should adjust the money supply to adjust to various shocks to the economy.

Question 75

Economic research finds that greater central-bank independence is ______ correlated with lower and more stable inflation as well as ______ correlated with the average growth and variability of real GDP.

A) strongly; strongly
B) strongly; not
C) not; strongly
D) not; not

Question 76

If a city passes laws limiting rents on apartments but promises to exempt buildings not yet built:

A) construction of new buildings will not be discouraged.
B) construction of new buildings may be discouraged.
C) builders will not expect the city to renege on its promise.
D) the city will have no incentive to renege on its promise.

Question 77

A monetary policy rule that targets nominal GDP would ______ money growth when nominal GDP rises above the target and ______ money growth when nominal GDP falls below the target.

A) reduce; raise
B) raise; reduce
C) reduce; reduce
D) raise; raise

Question 78

Research indicates that greater central-bank independence is correlated with:

A) higher average growth rates of real GDP.
B) lower rates of unemployment.
C) lower and more stable rates of inflation.
D) less volatility of real GDP.

Question 79

In practice, inflation targeting is better considered as operating with constrained discretion rather than according to a policy rule because central banks with inflation targets typically:

A) are not allowed to adjust the target in the event of shocks.
B) set the inflation target as a range rather than as a particular number.
C) are not held accountable for achieving their target.
D) must achieve their target regardless of economic conditions.

Question 80

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.