Deck 21: The Role of Expectations in Macroeconomic Policy

Question 1

Adaptive expectations are formed ________.

A) from experience
B) from best guesses about the future
C) as new information becomes available
D) as a weighted average of expert forecasts

Answer 1

from experience

Question 2

Under what circumstances might it be "rational" to rely on adaptive expectations?

Answer 2

Adaptive expectations are based on the past. An adaptive expectation is irrational only if there is reason to believe that it is possible to formulate a better guess. Though one can never be sure that the trends of the past will continue unaltered into the future, it may not be possible -- without undue expense -- to acquire enough information and understanding to justify the conclusion that the known trend will fail to persist. If the known trend has been reliable, there is no obvious reason to doubt its persistence, and there is no inexpensive way to conduct a forward-looking assessment, the adaptive expectation is rational.

Question 3

The "rational expectations revolution" refers to a substantial change in the thinking of ________.

A) households and businesses
B) policy makers
C) macroeconomists
D) elected officials

Answer 3

macroeconomists

Question 4

________ rational expectations, ________.

A) Most people have always formed; but macroeconomists have only recently come to recognize this fact
B) Macroeconomists have invented; and are trying to teach them to the general public
C) Policy makers have devised; in search of more effective policies
D) The latest information is an important input in; so most people must make do with adaptive expectations

Question 5

Rational expectations theory suggests that ________.

A) consumers base their expectations about the future largely on past experience.
B) economic agents will always alter their decision-making when a new piece of information becomes available.
C) economic agents will not be influenced by a piece of information if that information has already been anticipated.
D) consumers need not form expectations about the far flung future since most consumption decisions involve satisfying an immediate impulse, e.g. hunger.

Question 6

Suppose you need an estimate of future inflation (to decide, for example, whether a particular security is a good investment). How might you formulate a rational expectation?

Question 7

An economic policy has a decent chance of working as intended, if ________.

A) the policy causes no change in expectations
B) if mistaken expectations are not very costly
C) the rationale behind the policy is well-understood by the public
D) expectations are formed in the same way by both the public and the policymakers

Question 8

The danger in using data to estimate the consequences of a proposed policy is that ________.

A) the data can reveal only the benefits of a policy, while estimating the policy's costs is important, also
B) policies change so often that data can never reveal which policies are the cause of which consequences
C) the public's expectations about the policy might influence the data, making the policy seem more or less appropriate than is actually the case
D) the proposed policy, if implemented, might cause unforeseeable changes in the relationships that were in operation when the data were produced

Question 9

A prediction based on rational expectations ________.

A) relies solely on past experience.
B) will always be superior to one based on adaptive expectations.
C) is based on real, rather than nominal variables.
D) will not always be accurate.

Question 10

New information ought not to influence economic decision-making if ________.

A) consumers rely on rational expectations.
B) monetary policy changes.
C) monetary and/or fiscal policy changes
D) that information has already been anticipated.

Question 11

The notion that expectations will be identical to optimal forecasts using all available information is known as ________.

A) adaptive expectations.
B) irrational expectations.
C) rational expectations.
D) tertiary expectations.

Question 12

Assume that prices have risen in a given economy by an average of 5 percent over the last nine years. If consumers base their expectations about future price movements on that knowledge alone their forecasts rely on ________.

A) reverse expectations.
B) adaptive expectations.
C) rational expectations.
D) monetary expectations.

Question 13

Rational expectations theory suggests that ________.

A) policy announcements can impact behavior
B) policy announcements have no impact on behavior
C) unannounced policies have no impact on behavior
D) the optimal forecast is identical to the announced policy

Question 14

Economists use ________ to forecast economic activity and to evaluate policy options.

A) macroeconometric models
B) educated guesses
C) cost-benefit analysis
D) constrained discretion

Question 15

Both adaptive expectations and rational expectations are prone to error (a discrepancy between the expectation and the actual experience). In each case, how does error affect the formation of new expectations?

Question 16

Robert Lucas spurred the rational expectations revolution in ________.

A) the 1960s
B) the 1970s
C) the 2000s
D) the 1880s

Question 17

If households have information that monetary policy is likely to change in the future, that information will play a role in forming ________.

A) adaptive expectations.
B) rational expectations.
C) tertiary expectations.
D) non-adaptive expectations.

Question 18

Expectations about the future will always be accurate if formed under ________.

A) rational expectations.
B) adaptive expectations.
C) natural selection.
D) none of the above.

Question 19

Forecasts based on the extrapolation of observed trends and relationships are likely to be accurate, if ________.

A) changes in expectations are properly considered
B) policy actions are anticipated
C) economic behavior is guided by rational expectations
D) policy changes are understood to be permanent

Question 20

Rational expectations are more accurate than adaptive expectations, ________.

A) on average
B) always
C) because they require less information
D) except when policies have changed

Question 21

The time-inconsistency problem involves the ________.

A) difficulties of traveling across time zones.
B) tendency to deviate from good long-run plans in the short-run.
C) use of adaptive expectations in building an economic model.
D) time lag between the implementation of policy and its ultimate and complete results.

Question 22

The constant growth rate rule for money, as initially proposed by Milton Friedman, has been adjusted ________.

A) to take the problem of moral hazard in account.
B) to account for the role played by adaptive expectations in policy formation.
C) for the difference between real and nominal economic variables.
D) to allow for possible short-run movements in velocity.

Question 23

The argument that ________ receives strong support from the innovative policy response to the recent financial crisis.

A) rules can be too rigid
B) discretionary policies are vulnerable to the time-inconsistency problem
C) money is the sole source of fluctuations in aggregate demand
D) changes in policies can change the coefficients in macroeconometric models

Question 24

An example of the political business cycle in action came during the ________.

A) Roosevelt administration of the 1920s.
B) Nixon administration of the 1970s.
C) Reagan administration of the 1980s.
D) Bush administration of the 2000s.

Question 25

According to the Lucas critique, what is the proper way to evaluate a proposal that reduces government borrowing by raising taxes and reducing government spending?

Question 26

The Swiss National Bank established the practice of targeting monetary aggregates in________.

A) 1929.
B) 1975.
C) 2001.
D) 2008.

Question 27

The tendency to deviate from sound long-run plans in the short-run is known as ________.

A) the failure of adaptive expectations.
B) the failure of rational expectations.
C) the time inconsistency problem.
D) the NIMBY, or not in my backyard problem.

Question 28

Swiss experience in the 1980s evidences the ________.

A) effectiveness of targeting monetary aggregates.
B) need for discretion in the face of structural changes in the economy.
C) value of fiscal policy over monetary policy.
D) ascendancy of flexible exchange rate regimes over fixed exchange rate systems.

Question 29

When monetary policies result in a worsening of economic performance, the least likely explanation is ________.

A) a political business cycle
B) changes in one or more key structural parameters of the economy
C) a policy-induced change in the expectations and behaviors of households and businesses
D) faulty interpretation of incomplete and ambiguous economic data

Question 30

Swiss attempts to target monetary aggregates ended in the 1990s because ________.

A) the expectations of Swiss households had evolved from being adaptive to rational.
B) structural changes in the economy had rendered existing practices inflationary.
C) of the resulting increase in interest rates.
D) the ensuing deflation increased the real value of debt held by Swiss manufacturing firms.

Question 31

According to monetarists, such as Milton Friedman ________.

A) the central bank should have discretionary authority to respond to economic problems that develop over the course of the business cycle.
B) the Taylor rule should effectively address the problem of inflation.
C) an increase in government spending has substantially the same effects as an unanticipated increase in the money supply on domestic interest rates.
D) the money supply should grow at a constant rate regardless of the state of the economy.

Question 32

For monetarists, the sole source of fluctuations in aggregate demand is ________.

A) government spending and tax rates.
B) the velocity of money.
C) the supply of money.
D) international trade variables, i.e. exports and imports.

Question 33

In 1975 the Swiss National Bank announced a policy of targeting ________.

A) the level of income.
B) interest rates.
C) rational expectations.
D) monetary aggregates.

Question 34

The use of expansionary fiscal and monetary policy just prior to elections is known as the ________.

A) electoral college.
B) time-inconsistency problem.
C) Watergate scandal.
D) political business cycle.

Question 35

According to the Taylor rule ________.

A) expectations are formed in an adaptive fashion.
B) the central bank should set its federal funds rate target by a formula that puts weight on both output and inflation gaps.
C) a constant growth rate rule for money should be adopted.
D) expectations should be formed consistent with the model of rational expectations.

Question 36

Which of the following is most consistent with the time-inconsistency problem?

A) while it is ten o'clock in the morning in Chicago, it will be eleven o'clock in New York City.
B) a monetary policy action that is implemented in January will not begin to influence economic variables for several months.
C) a parent who acquiesces to a child's demand just to keep them quiet in a public setting.
D) an economic model with adaptive expectations.

Question 37

According to monetarist theory, responsibility for the Great Depression lays with ________.

A) the Federal Reserve System.
B) the liberal rulings of the Supreme Court.
C) the President and Congress of the United States.
D) unfair trade practices.

Question 38

The notion that the central bank should set its federal funds target by a formula that puts weight on both output and inflation gaps is known as ________.

A) the Taylor rule.
B) the constant growth rate rule for money.
C) the equation of exchange.
D) the Lucas rule.

Question 39

The political business cycle involves the ________.

A) expenditure of substantial funds by industry lobbyists to manipulate government regulation.
B) movement of individuals from government employment to positions within the industry they had previously participated in regulating.
C) use of expansionary fiscal policy just prior to elections.
D) election of government officials who are supportive of the government sector.

Question 40

Which of the following provides support for the use of discretion in economic policy-making?

A) any policy rule that is based on a particular model will prove wrong if that model is wrong.
B) the existence of a political business cycle.
C) the conclusions of Friedman and Schwartz with respect to monetary and fiscal policy.
D) the Watergate scandal.

Question 41

Evidence suggests that, with rare exceptions, economic policies are not manipulated in an effort to influence electoral outcomes. Use the Lucas critique to explain why not.

Question 42

Constrained discretion ________.

A) eliminates all discretion in policymaking.
B) imposes an inherent discipline on consumers.
C) imposes an inherent discipline on policymakers but does not eliminate all flexibility.
D) requires policymakers follow a constant growth rate rule for money.

Question 43

The tying down of the price level to a nominal variable by the central bank is known as committing to ________.

A) a nominal anchor.
B) rational expectations.
C) a customs union.
D) a positive aggregate demand shock.

Question 44

Consider two similar economies hit by the same temporary negative supply shock. In the economy with the more credible monetary policy, there will be ________.

A) smaller increases in both inflation and the real interest rate
B) a smaller increase in inflation and larger increase in the real interest rate
C) a smaller increase in inflation and larger decrease in output
D) a smaller increase in output and larger increase in the real interest rate

Question 45

The "anchor" that sustains the credibility of monetary policy is ________.

A) easily weighed during the slightest of macroeconomic storms
B) composed of some indestructible substance
C) necessary to avoid central bank independence
D) available for scrutiny to all who care to observe

Question 46

For the most part, central bank credibility, or lack thereof, is reflected in the behavior of ________.

A) short-run aggregate supply
B) short-run aggregate demand
C) long-run aggregate supply
D) aggregate price shocks

Question 47

The strength of the movement in the short-run aggregate supply schedule, in response to an aggregate demand shock is determined by ________.

A) the price elasticity of demand.
B) the credibility of the monetary authorities.
C) the underlying state of the economy.
D) the choice of nominal anchors.

Question 48

If the public believes that the commitment to a nominal anchor is not credible, the effect of a negative aggregate demand shock is for ________.

A) short-run aggregate supply to shift down
B) short-run aggregate supply to remain unchanged
C) short-run aggregate supply to shift up
D) inflation, but not economic activity, to decrease

Question 49

In 1973, 1979 and 2007, the U.S. economy was hit by ________.

A) the collapse of the financial sector.
B) the assassination of a Federal Reserve Board member.
C) three major aggregate supply shocks.
D) the after-effects of the process of creative destruction.

Question 50

If the public believes the commitment to a nominal anchor to be credible, the effect of a positive aggregate demand shock is for ________.

A) short-run aggregate supply to shift up
B) short-run aggregate supply to be unaffected
C) short-run aggregate supply to shift down
D) inflation, but not economic activity, to increase

Question 51

The immediate objective of a nominal anchor is to reduce the variability of ________.

A) monetary policy targets
B) expected inflation
C) aggregate demand
D) central bank credibility

Question 52

Of these policies, which is the best example of constrained discretion?

A) the annual federal budget deficit shall not exceed three percent of the GDP
B) the growth rate of the money supply, with appropriate adjustments for changes in the velocity of money, shall be between two percent and five percent
C) macroeconomic policies shall promote rapid economic growth and low inflation
D) macroeconomic policies shall aim to keep inflation -- on average over each five-year interval -- within a range of two percent to four percent,

Question 53

Monetary policy credibility has the benefit of ________.

A) stabilizing inflation in the short run when faced with positive demand shocks.
B) stabilizing economic activity in the short run when faced with positive demand shocks.
C) transmitting the effect of aggregate demand shocks onto short-run aggregate supply.
D) enhancing the job opportunities of Federal Reserve officials after they leave the central bank.

Question 54

The effects of the negative supply shocks of 1973, 1979 and 2007 were different due to the ________.

A) role played by rational expectations in the 1979 event
B) different sources of the supply shocks
C) credibility of the monetary authorities
D) different individuals who led the Federal Reserve System

Question 55

If the public believes the commitment to a nominal anchor to be credible, the effect of a negative aggregate demand shock is for ________.

A) short-run aggregate supply to shift up
B) short-run aggregate supply to be unaffected
C) short-run aggregate supply to shift down
D) inflation, but not economic activity, to decrease

Question 56

In the equation for the short-run aggregate supply curve, π = πe + γ + ρ, an improvement in the credibility of monetary policy is represented by a change in ________.

A) expected inflation
B) the price shock
C) the sensitivity of inflation to the output gap
D) the output gap

Question 57

How are rule-based policies similar to adaptive expectations?

Question 58

If the public believes that the commitment to a nominal anchor is not credible, the effect of a positive aggregate demand shock is for ________.

A) short-run aggregate supply to shift down
B) short-run aggregate supply to remain unchanged
C) short-run aggregate supply to shift up
D) inflation, but not economic activity, to increase

Question 59

One requirement for an effective nominal anchor is ________.

A) price stability.
B) credibility.
C) fixed exchange rates.
D) rational expectations.

Question 60

A nominal anchor helps policy makers to avoid ________.

A) adaptive expectations
B) constrained discretion
C) negative demand shocks
D) the time-inconsistency problem

Question 61

The current Chairman of the Board of Governors is ________.

A) Nancy Pelosi.
B) Alan Greenspan.
C) Ben Bernanke.
D) Barack Obama.

Question 62

In the United States, monetary policy has been particularly reliant on ________.

A) inflation targeting
B) independence from short-term political influences
C) effective opposition to any attempts at policy "reform"
D) conformity to "best practice" standards among the world's central banks

Question 63

One country that has not yet adopted inflation targeting is ________.

A) South Africa.
B) the United States.
C) Canada.
D) Mexico.

Question 64

The country with the highest degree of central bank independence in the period 1973-88 was ________.

A) the United States.
B) New Zealand.
C) Spain.
D) Germany.

Question 65

Inflation targeting makes more sense than unemployment targeting, because ________.

A) monetary policies affect inflation, not unemployment
B) expected unemployment is not a key determinant of the unemployment rate
C) a commitment to avoid high inflation is inherently more credible than a commitment to avoid high unemployment
D) most voters and most elected officials are more concerned about inflation

Question 66

The country with the lowest degree of central bank independence in the period 1973-88 was ________.

A) Germany.
B) Japan.
C) The United States.
D) Spain.

Question 67

The academic work of Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, suggests that he is a firm advocate of ________.

A) fixed exchange rates.
B) inflation targeting.
C) decreased central bank transparency.
D) electoral college reform.

Question 68

Paul Volcker was appointed to head the Federal Reserve System by ________.

A) Richard Nixon in 1969.
B) Jimmy Carter in 1979.
C) Ronald Reagan in 1992.
D) Barack Obama in 2009.

Question 69

The dual mandate of the Federal Reserve System is to maintain ________.

A) exchange rate and price stability.
B) price stability and maximum sustainable employment.
C) maximum sustainable employment and GDP growth.
D) GDP growth and exchange rate stability.

Question 70

Comment on the ability of a credible nominal anchor to allow policy makers to exploit a short-run trade-off between unemployment and inflation.

Question 71

Central bank credibility may be established by ________.

A) the appointment of individuals to the Fed with a strong aversion to inflation.
B) quicker responses to negative aggregate supply shocks.
C) greater coordination between monetary and fiscal policy.
D) the appointment of central bankers who are hawkish on defense.

Question 72

The negative supply shock of 2007, compared to the shocks in 1973 & 1979, involved ________.

A) a larger decrease in aggregate demand
B) larger decreases in the real interest rate
C) smaller decreases in aggregate supply
D) larger increases in the real interest rate

Question 73

Some members of the U.S. Congress are opposed to inflation targeting because it might ________.

A) give rise to a political business cycle
B) expose Federal Reserve policies to public scrutiny
C) result in higher unemployment
D) undermine the independence of the central bank

Question 74

During his tenure at the helm of the Federal Reserve System, Paul Volcker reestablished ________.

A) a system of fixed exchange rates.
B) the role of open market operations in the monetary policy actions of the Fed.
C) the credibility of the Federal Reserve as an inflation fighting institution.
D) the targeting of monetary aggregates, like the fed funds rate.

Question 75

Central bank independence ________.

A) is receding as democratic movements gain influence around the world
B) is correlated with relatively high unemployment
C) remains an obstacle to policy transparency
D) is the norm in a growing number of countries

Question 76

Which of the following is least likely to enhance central bank credibility?

A) "town meetings" on the topic of monetary policy
B) policy makers' expertise
C) independence from short-run political influences
D) accurate measurement of macroeconomic variables

Question 77

Greater central bank independence is positively related to ________.

A) a low rate of unemployment.
B) the length of terms of Governors on the Board of Governors.
C) a higher level of GDP.
D) the ability to fight inflation.

Question 78

The effects of the negative supply shocks of 1973, 1979 and 2007 were different due to the ________.

A) willingness of policy makers, in the earlier episodes, to cause a sharp increase in unemployment, in order to keep inflation low
B) coincidence, in 2007, of politically-motivated expansionary policies to lower unemployment
C) collapse of savings banks and real estate markets in the 1970s
D) need, in the earlier episodes, to resort to severely contractionary monetary policy

Question 79

Inflation targeting involves public disclosure of each of the following, except ________.

A) policy makers' plans and objectives
B) explanation of discrepancies between target inflation and actual inflation
C) the federal government debt ceiling
D) projections of macroeconomic conditions

Question 80

Which of the following is not an aspect of inflation targeting?

A) institutional commitment to a dual mandate
B) the public announcement of medium-term numerical inflation targets
C) increased accountability of the central bank
D) increased transparency of monetary policy