Deck 13: Macroeconomic Policy and Aggregate Demand and Supply Analysis

Question 1

A good reason for policy makers to pursue a goal of stabilizing economic activity is that ________.

A) high unemployment is always accompanied by high variability of unemployment
B) in a stable economy, there is little or no frictional unemployment
C) in a stable economy, there is little or no structural inflation
D) all of the above
E) none of the above

Answer 1

none of the above

Question 2

Which of the following is a likely objective of monetary policy?

A) Achieving a zero inflation gap
B) Stabilizing economic activity
C) avoiding large changes in unemployment
D) all of the above
E) none of the above

Answer 2

all of the above

Question 3

How do the hierarchical and dual mandates differ in terms of macroeconomic consequences?

Answer 3

A dual mandate implies more tolerance of inflation than a hierarchical mandate. Ceteris paribus, the creation and purchasing power of wealth receive more support from a hierarchical mandate. A dual mandate implies less tolerance of positive output gaps and more support for aggregate demand.

Question 4

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007. Which of the following is a likely result of this financial disruption?

A) The AD curve likely shifted left which caused a positive inflation gap
B) The AD curve likely shifted right which caused a positive inflation gap
C) The AD curve likely shifted left which caused an upward movement along the MP curve to a higher general equilibrium interest rate
D) The AD curve likely did not shift
E) none of the above

Question 5

Some central banks pursue price stability before they pursue other goals. Which of the following central banks have this kind of hierarchical mandate? i. Bank of England
Ii) Bank of Canada
Iii) European Central Bank
Iv) Federal Reserve (U.S.A.)

A) i, ii, and iv only
B) i and iii only
C) i and iv only
D) ii, iii, and iv only
E) none of the above

Question 6

Every six weeks, the Federal Open Market Committee (FOMC) meets to discuss monetary policy. This discussion is mainly focused on ________.

A) information of the equilibrium real interest rate from the past three years
B) the current month's release of the CPI by the BLS
C) the three year projections of the equilibrium real interest rate
D) the past 18 month history and future 18 month projections of the discount rate
E) none of the above

Question 7

In recent decades, the trend among central banks has been to adopt ________.

A) high employment as a central goal
B) a dual mandate that gives equal weight to both price stability and low unemployment.
C) price stability as a central goal
D) a target of zero inflation
E) none of the above

Question 8

Every six weeks, the Federal Open Market Committee (FOMC) meets to discuss how to best adjust ________ to accommodate shocks that shift the level of ________.

A) the equilibrium real interest rate; the target Fed Funds rate
B) the target Fed Funds rate; the equilibrium real interest rate
C) the 3 month T-bill rate; the inflation gap
D) target rate of inflation; money demand
E) none of the above

Question 9

A change in the equilibrium real interest rate may result from ________.

A) an autonomous monetary policy
B) a change in the central bank's target inflation rate
C) a change in expected inflation
D) all of the above
E) none of the above

Question 10

A good reason for policy makers to pursue a goal of stabilizing economic activity is that ________.

A) high inflation is always accompanied by high variability of inflation
B) high unemployment causes human misery and lost output
C) in a stable economy, there is little or no structural inflation
D) all of the above
E) none of the above

Question 11

Frictional unemployment is to ________ as structural unemployment is to ________.

A) search; mismatch
B) temperature; rigidity
C) job training; output gap
D) all of the above
E) none of the above

Question 12

A central bank with a hierarchical mandate will seek ________ as a condition of pursuing other goals.

A) stable inflation
B) high employment
C) moderate interest rates
D) the approval of the legislature
E) none of the above

Question 13

Which of the following is a likely objective of monetary policy?

A) Achieving price stability
B) Stabilizing economic activity
C) Closing the output gap to zero
D) all of the above
E) none of the above

Question 14

Which of the following is a primary objective of macroeconomic policy?

A) Achieving a zero rate of unemployment
B) Achieving a zero rate of inflation
C) Stabilizing economic activity
D) all of the above
E) none of the above

Question 15

Ceteris Paribus, if current output has fallen below potential ________.

A) a positive inflation gap will ensue
B) it is likely that the equilibrium real rate has fallen below the policy rate
C) a negative unemployment gap will ensue
D) it is likely that the equilibrium real rate has risen above the policy rate
E) none of the above

Question 16

Which of the following is a primary objective of monetary policy?

A) Achieving a zero natural rate of unemployment
B) Targeting a zero rate of inflation
C) Achieving price stability
D) all of the above
E) none of the above

Question 17

Shocks to the macroeconomy will cause a change in the equilibrium real interest rate, except ________.

A) permanent supply shocks
B) aggregate demand shocks
C) temporary supply shocks
D) all of the above
E) none of the above

Question 18

Suppose that inflation is at the target rate and output has fallen substantially below potential output. A central bank with a primary objective of price stability should ________.

A) do nothing, because inflation cannot rise when unemployment is high
B) ease monetary policy, to avoid a decrease in the inflation rate
C) do nothing, because stabilizing economic activity is not a primary objective
D) ease monetary policy, because avoiding high unemployment is more important than avoiding high inflation
E) none of the above

Question 19

The goal of maximum sustainable employment is roughly equivalent to achieving ________.

A) the natural rate of unemployment
B) an inflation target that is slightly above zero
C) the elimination of frictional and structural unemployment
D) all of the above
E) none of the above

Question 20

The equilibrium real interest rate is the rate ________.

A) at which the output gap is zero
B) at which the inflation rate is low
C) controlled by the central bank
D) all of the above
E) none of the above

Question 21

If most shocks to the economy are ________ shocks, then ________.

A) aggregate demand; there is a tradeoff between the dual objectives in the short-run
B) temporary aggregate supply; inflation stabilization policy will not stabilize activity in the short-run
C) temporary aggregate supply; output stabilization policy is consistent with no change in inflation in the long-run
D) all of the above
E) none of the above

Question 22

Suppose the economy is in a long-run equilibrium when a temporary, favorable aggregate supply shock occurs. On the graphs above, show what happens to bring the economy back to long-run equilibrium, assuming that there is no policy response. In words, explain why "no response" is the best policy.

Question 23

A negative shock in aggregate demand will likely result in ________.

A) a permanent change in output, unless the central bank responds by lowering interest rates
B) a permanently lower equilibrium inflation rate, unless the central bank responds by lowering interest rates
C) an eventual increase in aggregate supply for any inflation rate, if the central bank responds by lowering interest rates
D) all of the above
E) none of the above

Question 24

When a permanent negative supply shock hits the economy ________.

A) in the long-run, the output gap returns to zero only if the central bank raises interest rates
B) the long-run equilibrium level of output depends on whether and how the central bank responds
C) there is no permanent effect on inflation if the central bank raises interest rates
D) all of the above
E) none of the above

Question 25

The time it takes for policymakers to obtain and to understand the data and to change the policy instrument based on that information is known as ________.

A) the data, recognition, and effectiveness lags, respectively
B) the recognition, data, and effectiveness lags, respectively
C) the data, recognition, and implementation lags, respectively
D) the recognition, implementation, and effectiveness lags, respectively
E) none of the above

Question 26

If most shocks to the economy are ________ shocks, then ________.

A) aggregate demand; inflation stabilization policy will also stabilize activity in the short-run
B) permanent aggregate supply; inflation stabilization policy will also stabilize activity in the short-run
C) temporary aggregate supply; inflation stabilization policy has no impact on economic activity in the long-run
D) all of the above
E) none of the above

Question 27

When a permanent negative supply shock hits the economy ________.

A) a permanently lower equilibrium level of output ensues if the central bank raises interest rates
B) a permanently lower equilibrium level of output ensues if the central bank does not respond
C) a permanently higher equilibrium level of inflation ensues if the central bank does not respond
D) all of the above
E) none of the above

Question 28

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007. Which of the following is a likely result of this financial disruption?

A) The AD curve likely shifted left which caused a negative output gap
B) The AD curve likely shifted left which caused a positive inflation gap
C) The AD curve likely shifted left which caused an upward movement along the MP curve to a higher general equilibrium interest rate
D) The AD curve likely did not shift
E) none of the above

Question 29

If higher inflation ensues from a temporary negative supply shock, and in response, the central bank raises interest rates, then the resulting decrease in AD will return inflation back to its original level ________.

A) and no further action will be required by the central bank
B) but the ensuing positive output gap will lead to higher inflation once again so further interest rate increases will be required by the central bank to return inflation back to its long run level
C) but the ensuing negative output gap will lead to short-run increases in AS and the central bank will have to "undo" its original interest rate hike in order to return inflation back to its target rate
D) all of the above
E) none of the above

Question 30

If higher inflation ensues from a temporary negative supply shock, and in response, the central bank raises interest rates, then ________.

A) it is likely adopting a policy to stabilize inflation in the short run
B) short-run inflation will fluctuate around (first go higher then go lower than) the long run level of inflation
C) it will need to lower interest rates back to their original values to ensure that inflation returns to its original rate
D) all of the above
E) none of the above

Question 31

When an aggregate demand shock hits the economy ________.

A) there is no conflict for the central bank between pursuing price or output stability because of the divine coincidence
B) the same long-run equilibrium real interest rate is reached whether the central bank intervenes or not
C) the long-run level of output is unaffected
D) all of the above
E) none of the above

Question 32

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007. Which of the following is a likely result of this financial disruption?

A) The AD curve likely shifted left which caused a negative output gap
B) The AD curve likely shifted left causing a negative inflation gap
C) The AD curve likely shifted left followed by an downward movement along the MP curve to a lower equilibrium interest rate in the short run
D) all of the above
E) none of the above

Question 33

When a temporary negative supply shock hits the economy ________.

A) the divine coincidence does not always hold
B) the divine coincidence holds in the short-run
C) the divine coincidence does not hold in the long-run
D) all of the above
E) none of the above

Question 34

A negative shock in aggregate demand will likely result in ________.

A) no permanent change in output
B) no permanent change in the equilibrium inflation rate if the central bank responds by lowering interest rates
C) an increase in aggregate demand for any inflation rate, if the central bank responds by lowering interest rates
D) all of the above
E) none of the above

Question 35

A negative shock in aggregate demand will likely result in ________.

A) a short run decrease in output
B) a permanently lower equilibrium inflation rate if the central bank does not respond by lowering interest rates
C) an eventual increase in aggregate supply for any inflation rate if the central bank does not respond by lowering interest rates
D) all of the above
E) none of the above

Question 36

When a permanent negative supply shock hits the economy ________.

A) in the long-run, output is permanently lowered whether the central bank reacts or not
B) inflation decreases in the short-run
C) there is no long-run effect on inflation whether the central bank reacts or not
D) all of the above
E) none of the above

Question 37

Suppose the economy is in a long-run equilibrium when a positive demand shock occurs. On the graphs above, show what happens to bring the economy back to long-run equilibrium, assuming that there is no policy response. In words, describe how the graph would be different, if policy makers did intervene.

Question 38

What is the divine coincidence? When and why does it not hold true?

Question 39

When a temporary negative supply shock hits the economy, then in the short-run ________.

A) if the central bank focuses on stabilizing output, it cannot stabilize inflation
B) if the central bank focuses on stabilizing inflation, it cannot stabilize output
C) the divine coincidence does not hold
D) all of the above
E) none of the above

Question 40

A negative shock in aggregate demand will likely result in ________.

A) a permanent change in output, if the central bank responds by lowering interest rates
B) no permanent change in the equilibrium inflation rate, unless the central bank responds by lowering interest rates
C) an eventual increase in aggregate supply for any inflation rate, if the central bank responds by lowering interest rates
D) all of the above
E) none of the above

Question 41

What do the legislative and implementation lags have in common?

A) They are both more important for monetary than fiscal policy
B) They are both more important for fiscal than monetary policy
C) They are both harder to measure but less variable than the effectiveness lag
D) They both take place before the data and recognition lags
E) none of the above

Question 42

Aggregate Demand and Supply Analysis

In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion. If there is no policy intervention, we should expect ________.

A) rightward shifts of IS & AD, so that both output and inflation rise
B) a decrease in inflation to shift the MP curve, raising the real interest rate
C) declines in both the inflation rate and the real interest rate as output rises
D) a decrease in inflation to shift the AD curve, causing output to rise
E) none of the above

Question 43

According to the Taylor rule, which of the following will lead to a higher nominal federal funds rate?

A) a decrease in inflation
B) a negative output gap
C) a positive inflation gap
D) all of the above
E) none of the above

Question 44

According to the Taylor rule, which of the following will lead to a higher nominal federal funds rate?

A) an increase in inflation
B) a positive output gap
C) a positive inflation gap
D) all of the above
E) none of the above

Question 45

How might long policy lags impact the divine coincidence?

Question 46

Aggregate Demand and Supply Analysis

In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion. If a fiscal stimulus package is implemented quickly, raising output to $12 trillion, while inflation remains constant at one percent, then the figure implies that the real interest rate will be ________ percent.

A) 1.5
B) zero
C) one
D) 0.5
E) 2.5

Question 47

The American Recovery and Reinvestment Act of 2009 ________.

A) placed greater emphasis on monetary policy than fiscal policy
B) finally put an end to the inflationary spiral that had begun in 2005
C) was intended to reverse the sharp increase in the equilibrium real interest rate
D) all of the above
E) none of the above

Question 48

According to the Taylor rule, which of the following will lead to the largest increase in the nominal federal funds rate?

A) a two percentage point increase in the target inflation rate
B) a one percentage point decrease in the target inflation rate
C) a one percentage point increase in output
D) a two percentage point decrease in output
E) a one percentage point increase in the inflation rate

Question 49

An emphasis on inflation stability is compatible with a nonactivist stance only when shocks to the macroeconomy are ________.

A) permanent supply shocks
B) temporary supply shocks
C) aggregate demand shocks
D) all of the above
E) none of the above

Question 50

Suppose that wages and prices are quite flexible, so that the short-run aggregate supply curve is steep. In that case, ________.

A) policies to stabilize inflation are probably needed more than policies to stabilize economic activity
B) supply shocks will destabilize inflation, but have minimal impact on output
C) demand shocks will destabilize output, but have minimal impact on inflation
D) all of the above
E) none of the above

Question 51

How might openness to the global economy influence the debate between policy activists and nonactivists?

Question 52

Activists believe that ________.

A) frictions to the self-correcting mechanism of markets prevent prices and wages from being very flexible
B) it takes a very long time to reach the long run
C) Keynes was right with his statement "in the long-run, we are all dead"
D) all of the above
E) none of the above

Question 53

Aggregate Demand and Supply Analysis

In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion. If there is no policy intervention, then the figure implies that when output has reached $12 trillion, the real interest rate will be ________ percent, and the inflation rate will be ________ percent.

A) 1.5; one
B) one; zero
C) zero; minus 2
D) 0.5; minus one
E) 2.5; three

Question 54

Which statement is a good argument in support of policy activism?

A) Policy lags are generally longer than the time it takes the self-correcting mechanism to work.
B) Activist policies help to ensure stability of the real interest rate.
C) Well-considered policies can assist the economy's self-correcting mechanism, thus reducing the variability of inflation and unemployment.
D) all of the above
E) none of the above

Question 55

The American Recovery and Reinvestment Act of 2009 ________.

A) was a result of the Obama administration adopting an activist approach to policymaking
B) is still being debated after the fact in terms of its effectiveness
C) was supported by some economists, and opposed by as many economists
D) all of the above
E) none of the above

Question 56

Aggregate Demand and Supply Analysis

In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion. If autonomous monetary policy (alone) is used to bring output to $12 trillion, then the figure implies that the real interest rate will be ________ percent, and the inflation rate will be one percent.

A) 1.5
B) zero
C) one
D) 0.5
E) 2.5

Question 57

Nonactivists believe that ________.

A) there is a very rapid self-correcting mechanism since prices and wages are very flexible
B) lags to policy implementation are so long that even the "correct" policies may lead to undesirable consequences
C) policy interventions should take place less frequently than what Keynesians advocate
D) all of the above
E) none of the above

Question 58

Aggregate Demand and Supply Analysis

In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion. Suppose that a combination of fiscal stimulus and recovery of consumer and business confidence shifts the IS and AD curves, as shown in the figure, while monetary policy sets the real interest rate at one percent. If the short-run aggregate supply curve is π = Y - 13, then the resulting values of output and inflation are ________.

A) $12 trillion & 3 percent
B) $13.5 trillion & 5 percent
C) $9.75 trillion & 0 percent
D) $13.5 trillion & 0 percent
E) $12.5 trillion & 2 percent

Question 59

Aggregate Demand and Supply Analysis

In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion. Suppose that a combination of fiscal stimulus and recovery of consumer and business confidence shifts the IS and AD curves, as shown in the figure. The equilibrium real interest rate is ________ percent.

A) 3
B) one
C) 2.5
D) 2
E) zero

Question 60

Suppose that data for a particular economy over time suggest that its aggregate demand curve is both steep and shifts frequently. We might reasonably infer that ________.

A) the central bank has an activist emphasis on the stability of economic activity
B) wages and prices are remarkably flexible
C) policy lags are quite long
D) all of the above
E) none of the above

Question 61

Which of the following statements is correct?

A) Through autonomous monetary policy adjustments the Federal Reserve can ultimately determine the equilibrium real interest rate in the long run
B) Through autonomous monetary policy adjustments the Federal Reserve can ultimately determine potential output in the long run
C) Through autonomous monetary policy adjustments the Federal Reserve can target any inflation rate in the long run
D) all of the above
E) none of the above

Question 62

"With autonomous changes in the policy interest rate, the Federal Reserve cannot determine the long run equilibrium level of the real interest rate or potential output and will only be able to determine inflation." This statement is consistent with ________

A) the notion that shifts in the MP curve may lead to shifts in the AD and AS curves but the LRAS remains unchanged
B) the notion of long-run independence between nominal and real variables
C) the notion of monetary neutrality
D) all of the above
E) none of the above

Question 63

If workers push for wages that are beyond what productivity gains can justify ________.

A) a temporary negative supply shock ensues driving up prices
B) a negative output gap ensues which will lead to higher unemployment if the Federal Reserve does not act
C) and the Federal Reserve eases monetary policy aimed at increasing aggregate demand to counter the negative supply shock, a price-wage spiral could ensue
D) all of the above
E) none of the above

Question 64

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) monetary policy would ultimately lead to higher inflation and real interest rates in the long run
B) monetary policy would ultimately lead to higher inflation and thus higher potential output
C) monetary policy would ultimately lead to higher potential output and real interest rates but no long-run impact on inflation
D) all of the above
E) none of the above

Question 65

Is the Taylor rule of greater use to activist or to nonactivist policy makers?

Question 66

Cost-push inflation is to ________ as demand-pull inflation is to ________.

A) impatience; inaccuracy
B) entering; exiting
C) activism; nonactivism
D) fiscal; monetary
E) none of the above

Question 67

If the inflation rate target is 2%, the current inflation rate is 1%, and the output gap is minus 2%, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.

A) zero
B) two
C) four
D) three
E) none of the above

Question 68

In 2008 and 2009, the federal funds rate was well below the rate suggested by the Taylor rule. A likely explanation for the discrepancy is that ________.

A) the Fed's dual mandate prevents a close reliance on the Taylor rule.
B) policy makers decided that the Taylor rule underestimates the risk of inflation
C) the Taylor rule is not intended to guide policy in response to aggregate supply shocks
D) all of the above
E) none of the above

Question 69

An activist policy to promote high employment ________.

A) could lead to inflationary pressures from an ensuing temporary negative supply shock
B) might incentivize workers to push for higher wages beyond what productivity gains can justify
C) could lead to inflationary pressures from an ensuing increase in aggregate demand
D) all of the above
E) none of the above

Question 70

A goal of very high employment may lead to ________.

A) inflationary monetary policy
B) inflationary fiscal policy
C) demand-pull inflation
D) all of the above
E) none of the above

Question 71

Which of the following statements is correct?

A) Through autonomous monetary policy adjustments the Federal Reserve can target any inflation rate in the long run
B) Ultimately, autonomous monetary policy adjustments by the Federal Reserve cannot determine the equilibrium real interest rate in the long run
C) Ultimately, autonomous monetary policy adjustments by the Federal Reserve cannot determine long run aggregate output
D) all of the above
E) none of the above

Question 72

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would likely conduct an easing of monetary policy by raising the real interest rate for any given inflation rate
B) it would likely conduct a tightening of monetary policy by raising the real interest rate for any given inflation rate
C) it would likely conduct an easing of monetary policy where the real interest rate would increase due to the ensuing decrease in aggregate demand
D) it would likely conduct a tightening of monetary policy where the real interest rate would increase due to the ensuing increase in aggregate demand
E) none of the above

Question 73

If the inflation rate target is 2%, the current inflation rate is 3%, and the output gap is 2%, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.

A) 4.5
B) 7
C) 6.5
D) 5.5
E) none of the above

Question 74

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would likely conduct an easing of monetary policy by lowering the real interest rate for any given inflation rate
B) an increase in aggregate demand would ensue generating a positive output gap
C) an eventual decrease in short-run AS would drive the long-run equilibrium level of inflation up
D) all of the above
E) none of the above

Question 75

Is the Taylor rule compatible with a hierarchical mandate?

Question 76

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) monetary policy would ultimately lead to higher potential output but real interest rates and inflation would be unaffected in the long run
B) monetary policy would ultimately lead to higher inflation but real interest rates and potential output would be unaffected in the long run
C) monetary policy would ultimately lead to higher interest rates but potential output and inflation would be unaffected in the long run
D) monetary policy would ultimately lead to higher interest rates, potential output, and inflation in the long run
E) none of the above

Question 77

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would conduct monetary policy consistent with a downward shift of the MP curve
B) it would conduct monetary policy that would lead to a rightward shift of the AD curve
C) after an easing of monetary policy, an eventual decrease in short-run AS would drive the long-run equilibrium level of inflation up
D) all of the above
E) none of the above

Question 78

If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would likely conduct a tightening of monetary policy by raising the real interest rate for any given inflation rate
B) it would likely conduct an easing of monetary policy by lowering the real interest rate for any given inflation rate
C) it would likely conduct an easing of monetary policy where the real interest rate would increase due to the ensuing decrease in aggregate demand
D) it would likely conduct a tightening of monetary policy where the real interest rate would increase due to the ensuing increase in aggregate demand
E) none of the above

Question 79

If workers push for wages that are beyond what productivity gains can justify ________.

A) a positive output gap ensues which will lead to lower unemployment if the Federal Reserve does not act
B) a temporary negative supply shock ensues driving up prices
C) and the Federal Reserve eases monetary policy aimed at increasing aggregate demand to counter the negative supply shock, the inflation rate will decrease
D) all of the above
E) none of the above

Question 80

If the inflation rate target is 2%, the current inflation rate is also 2%, and the output gap is zero, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.

A) zero
B) two
C) four
D) three
E) none of the above