Question 1

Economists who view the economy as naturally stable often argue that:

Accepted Answer

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. A

Question 2

Assume that in a certain economy the LM curve is given by Y = 2,000r - 2,000 + 2(M/P) + u, where u is a shock that is equal to +200 half the time and -200 half the time, and the IS curve is given by Y = 8,000 - 2,000r. The price level (P) is fixed at 1.0. The natural rate of output is 4,000. The government wants to keep output as close as possible to 4,000 and does not care about anything else. Consider the following two policy rules: i. Set the money supply M equal to 1,000 and keep it there. ii. Manipulate M from day to day to keep the interest rate constant at 2 percent. a. Under rule i, what will $Y$ be when $u = + 200$ ? Under rule i, what will $Y$ be when $u = - 200$ ?
b. Under rule ii, what will $Y$ be when $u = + 200$ ? Under rule ii, what will $Y$ be when $u = - 200$ ?
c. Which rule will keep output closer to 4,000 ?

Accepted Answer

a. $Y = 4,100$ when $u = + 200$.
$Y = 3,900$ when $u = - 200$.
b. $Y = 4,000$ when $u = + 200$.
$Y = 4,000$ when $u = - 200$.
c. Rule ii will keep $Y$ closer to 4,000.

Question 3

Advocates of passive policy argue that because monetary and fiscal policy lags are:

Accepted Answer

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. B

Question 4

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

Accepted Answer

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 5

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.

Accepted Answer

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

Question 6

Let the symbol $\pi$ stand for the rate of inflation, with E $\pi$ the expected inflation rate, both measured in percent. The letter u is the unemployment rate and uⁿ is the natural rate of unemployment. Suppose the short-run Phillips curve is u = uⁿ - $\alpha$( $\pi$ - E $\pi$) applies in a certain economy. The Fed's loss function is L(u, $\pi$) = u + $\gamma$ $\pi$². The analysis in the appendix to textbook Chapter 18 shows that if the Fed minimizes its loss function under the assumption that E $\pi$ is fixed and "rational" private agents know this, the expected inflation rate will be E $\pi$ =$\alpha$/2$\gamma$, and this will also be the inflation rate the government chooses. a. Suppose that $\alpha = 0.5$ and $y = 0.05$. What are the expected and actual inflation rates? b. Suppose $\alpha = 0.5$ and $y = 0.50$. In this case, does the Fed have greater or lesser relative distaste for inflation than in part a? What are the expected and actual inflation rates with $\gamma =$ $0.50$ ? Why do they differ from the inflation rates in part a?

Accepted Answer

The answer of Let the symbol  $\pi$ stand for...

Question 7

Economic science has provided convincing evidence in favor of the:

Accepted Answer

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 8

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:

Accepted Answer

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

Question 9

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

Accepted Answer

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 10

The outside lag is the time:

Accepted Answer

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 11

The time-inconsistency problem in discretionary policymaking about unemployment and inflation can be effectively avoided when the:

Accepted Answer

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 12

Keeping the money supply constant over the business cycle is an example of:

Accepted Answer

A)   active monetary policy.
B)   active fiscal policy.
C)   passive monetary policy.
D)   passive fiscal policy.

Question 13

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 ______.

Accepted Answer

A)   higher; lower
B)   higher; the same
C)   lower; lower
D)   lower; the same

Question 14

Is the independence of the central bank of any country directly related to that country's economic growth?

Accepted Answer

The answer of Is the independence of the central bank...

Question 15

Automatic stabilizers:

Accepted Answer

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 16

The concerns of economists who favor passive over active policy are most closely associated with their:

Accepted Answer

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.

Question 17

A policy rule:

Accepted Answer

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 18

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

Accepted Answer

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 19

Computer models of the economy:

Accepted Answer

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 20

The time between when government spending increases and when aggregate demand starts to increase is an example of an:

Accepted Answer

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

Exam 18: Alternative Perspectives on Stabilization Policy