Deck 15: Stabilization Policy

Question 1

Which of the following would tend to justify the use of stabilization policy despite the existence of implementation lags?

A) crowding out
B) Ricardian equivalence
C) sticky wages
D) information lags
E) the economy's self-correcting mechanism

Answer 1

sticky wages

Question 2

The difference between crowding out and Ricardian equivalence is

A) crowding out is only caused by government purchases; Ricardian equivalence results only from tax cuts
B) crowding out occurs because interest rates rise; under Ricardian equivalence interest rates fall
C) crowding out shifts the IS curve outward; Ricardian equivalence shifts the LM curve inward
D) crowding out makes monetary policy ineffective; Ricardian equivalence makes fiscal policy ineffective
E) crowding out occurs if tax cuts are spent; Ricardian equivalence occurs if they are saved

Answer 2

crowding out occurs if tax cuts are spent; Ricardian equivalence occurs if they are saved

Question 3

Which of the following would be an appropriate stabilization policy in response to an adverse demand shock?

A) an income tax increase
B) a reduction in government purchases
C) a reduction in transfer payments
D) a reduction of interest rates
E) wage and price controls

Answer 3

a reduction of interest rates

Question 4

Crowding out refers to

A) excess demand for a good of which there is a shortage
B) the negative effect of government budget deficits on investment
C) consumers saving tax cuts in anticipation of future tax increases
D) decisions that appear optimal in one period and sub-optimal at a later time
E) the implementation lag associated with fiscal policy

Question 5

The Phillips Curve illustrates a short run relationship between

A) inflation and interest rates
B) interest rates and income
C) interest rates and exchange rates
D) income and unemployment
E) unemployment and inflation

Question 6

The empirical relationship between inflation and unemployment is known as

A) the short run aggregate supply curve
B) the Phillips Curve
C) Okun's Law
D) Ricardian equivalence
E) the Laffer curve

Question 7

Which of the following creates the least risk that stabilization policy will be either ineffective or counterproductive?

A) Uncertainty regarding the magnitude of the expenditure multiplier
B) The possibility of a Ricardian-equivalence saving response to a tax cut perceived to be temporary
C) The likelihood of crowding out following a tax reduction
D) The decision lag associated with monetary policy
E) The implementation lag associated with fiscal policy

Question 8

In response to an adverse supply shock,

A) demand management could be used to restore the initial equilibrium
B) stabilizing prices would exacerbate the recession
C) interest rate hikes could be used to fend off inflation and prevent recession
D) fiscal policy can be used to push aggregate supply outward
E) a tax cut could stabilize GDP and the price level

Question 9

Which of the following is an appropriate stabilization policy for an economy in recession?

A) an open-market sale
B) a tax increase
C) a reduction of transfer payments
D) an increase in the discount rate
E) an increase in government purchases

Question 10

Under which of the following circumstances would stabilization policy be ineffective but not counterproductive?

A) There is a negative output gap of $60 billion, the expenditure multiplier is 3, and government increases its purchases by $20 billion
B) There is a positive output gap of $10 billion, the expenditure multiplier is 2, and government reduces its purchases by $20 billion
C) The implementation lag for stabilization policy is of such length that the economy corrects itself before the policy has an impact
D) Expansionary fiscal policy crowds out investment on a dollar-for-dollar basis
E) The inflation resulting from an adverse supply shock is misinterpreted as being the result of a demand shock

Question 11

Suppose the economy is initially operating at its long run equilibrium. In the absence of stabilization policy,a sudden sharp reduction in exports due to recession overseas would cause

A) an inward shift of aggregate supply, followed by a slow outward shift of aggregate demand
B) an inward shift of aggregate demand, followed by an inward shift of aggregate supply
C) an outward shift of aggregate demand, followed by a slow inward shift of aggregate supply
D) a recession accompanied by inflation
E) a relatively short recession followed by a long, slow recovery

Question 12

In the short run,which of the following would most likely result from an increase in interest rates?

A) a reduction in both equilibrium output and the price level
B) an increase in the equilibrium price level and a reduction in equilibrium output
C) a reduction in the equilibrium price level and an increase in equilibrium output
D) an increase in both equilibrium GDP and the price level
E) an increase in the equilibrium price level and no change in output

Question 13

Compared to monetary policy,fiscal policy

A) has a shorter decision lag
B) is used for more purposes and seeks to achieve more goals
C) is a more flexible tool for stabilization
D) is less likely to be offset by changes in household or firm behavior
E) is not subject to as much information lag

Question 14

For an economy operating at capacity,an income tax reduction should

A) cause capacity to expand
B) reduce interest rates
C) induce inflation
D) initiate a recession
E) shift the LM curve outward

Question 15

According to the short run Phillips Curve model,if the inflation rate is above the rate anticipated by the general public,then

A) the unemployment rate will be equal to the non-inflation-accelerating rate of unemployment (NIARU)
B) the unemployment rate will be at the natural rate
C) the unemployment rate will probably be exceptionally low
D) there will most likely be substantial cyclical unemployment in the economy
E) an adverse aggregate supply shock has created both inflation and unemployment

Question 16

A reduction in personal saving would shift

A) the IS curve downward
B) both the IS curve and the aggregate demand curve outward
C) the LM curve inward
D) both the LM curve and the aggregate supply curve inward
E) the aggregate demand curve inward and the aggregate supply curve downward

Question 17

US data fit the pattern of a short run Phillips Curve better in the 1960s than in the 1970s primarily because

A) government used more demand management in the 1970s than in the 1960s
B) wages were more flexible in the 1960s than in the 1970s
C) oil price shocks in the 1970s shifted the Phillips Curve
D) the concepts of inflationary expectations and the natural rate of unemployment had not been introduced in the 1960s
E) the end of the Vietnam War in the 1970s fundamentally altered the natural rate of unemployment

Question 18

Which of the following is not a policy lag associated with stabilization policy?

A) The delays in statistical reporting of economic data
B) The time required for Congress or Parliament to pass a budget
C) The time it takes to obtain regulatory approval to market a new pharmaceutical product
D) The gradual completion of new investment by private corporations following an interest rate reduction
E) The interval between a tax cut and the completion of new household expenditures

Question 19

An inverse relationship between unemployment and inflation arises

A) as a mathematical definition, regardless of economic events
B) when technological shocks are the primary force of change in the economy and wage adjustments are rapid
C) when shifts in aggregate demand cause most of the fluctuations in the economy, and wages are sluggish
D) when aggregate demand is stable while aggregate supply is shifting
E) in the long run but not in the short run

Question 20

Which of the following is true of policy lags?

A) Decision lags are generally longer for fiscal policy than for monetary policy
B) Information lags are usually longer than implementation lags
C) For monetary policy, the decision lag is usually longer than the information lag
D) Altogether, policy lags generally take about 6 months
E) Because they are predictable, implementation lags have no adverse consequences for policy making

Question 21

The next questions refer to the following.
Suppose that, in the absence of supply shocks, the inflation-unemployment relationship is inflation rate = expected inflation rate + 2(natural rate of unemployment - actual unemployment rate).
A reasonable stabilization policy in these circumstances would involve

A) increasing the inflation rate to .06
B) reducing inflation through demand management
C) raising interest rates
D) shifting the short run Phillips Curve outward
E) an increase of .02 in the income tax rate

Question 22

Which of the following is not a valid argument for policy rules?

A) rules are more flexible than discretion for dealing with unpredictable shocks
B) well-functioning automatic stabilizers generally operate according to rules
C) private behavior can offset the effects of discretionary policy
D) time inconsistency can make short run and long run goals incompatible
E) discretionary policy can be destabilizing

Question 23

Which of the following would occur under a system of policy rules?

A) the decision lag would be nonexistent
B) the government would lose credibility
C) the central bank's independence and authority to make decisions as needed would be enhanced
D) there would be no sacrifice ratio
E) there would be no possibility of Ricardian equivalence

Question 24

A balanced budget rule which precluded a deficit in any fiscal year would

A) stabilize short- and medium-term GDP
B) exacerbate recessions
C) be equivalent to handing fiscal policy to an independent agency, just as monetary policy is handled by an independent central bank
D) create a more predictable environment conducive to investment
E) cause the national debt to rise at the same rate as inflation

Question 25

In which case is time-inconsistency most likely to occur?

A) the legislature approves a new budget with a tax increase to correct an overheating economy
B) the central bank conducts open market operations to raise interest rates
C) the European Central Banks buys dollars to alter the euro's exchange rate
D) a monopolist undertakes inventory investment in anticipation of high seasonal sales of its product
E) a consumer undertakes savings in anticipation of retirement

Question 26

The increase in unemployment needed to reduce inflation by 1% is called

A) the misery index
B) the sacrifice ratio
C) the multiplier
D) the credibility gap
E) the inflation decelerator

Question 27

The next questions refer to the following.
Suppose that, in the absence of supply shocks, the inflation-unemployment relationship is inflation rate = expected inflation rate + 2(natural rate of unemployment - actual unemployment rate).
If consumers expect an inflation rate of .06,the natural rate of unemployment is .05,and the actual unemployment rate is .07,then the actual inflation rate is

A) .02
B) .04
C) .06
D) .08
E) .10

Question 28

A tax cut

A) pushes the inflation-unemployment coordinates down (and to the right) along a short run Phillips Curve
B) pushes the inflation-unemployment nexus up and to the left along a short run Phillips Curve
C) shifts the Phillips Curve outward
D) shifts the Phillips Curve inward
E) makes the slope of the Phillips Curve steeper

Question 29

The next questions refer to the following.
Suppose that, in the absence of supply shocks, the inflation-unemployment relationship is inflation rate = expected inflation rate + 2(natural rate of unemployment - actual unemployment rate).
The sacrifice ratio in this case is

A) 2
B) 1
C) .5
D) .01
E) .005

Question 30

In the long run,the Phillips Curve

A) slopes downward
B) slopes upward
C) shifts outward indefinitely
D) is vertical
E) is horizontal

Question 31

Central bank independence

A) allows the central bank to pursue full employment policies without regard to inflation
B) shortens the information lag associated with monetary policy
C) prevents the central bank from having any significant impact on economic variables
D) removes the central bank from political influence and the government's inflationary bias
E) is a myth, since Federal Reserve chairmen have historically done the bidding of American presidents

Question 32

The next questions refer to the following.
Suppose that, in the absence of supply shocks, the inflation-unemployment relationship is inflation rate = expected inflation rate + 2(natural rate of unemployment - actual unemployment rate).
In the absence of stabilization policy,which of the following would most likely occur?

A) the natural rate of unemployment will rise to .07
B) the expected rate of inflation will fall to .02
C) in the long run, the inflation rate will be .04 and the unemployment rate will be .06
D) the Phillips Curve will shift outward over time
E) the inflation rate will rise to .07

Question 33

Which of the following would most likely imply a small sacrifice ratio?

A) a steep short run Phillips Curve
B) long implementation lags
C) low government and central bank credibility
D) a gradualist approach to disinflation
E) time-inconsistent fiscal policy-making

Question 34

The sacrifice ratio is likely to be quite small if

A) the short run Phillips Curve is relatively flat
B) consumers are skeptical of policy-makers
C) the central bank enjoys strong credibility
D) inflationary expectations are not very adaptive
E) all of the above

Question 35

Time-inconsistency in monetary policy is most likely to create

A) long information lags
B) long decision lags
C) long implementation lags
D) low credibility
E) low sacrifice ratios

Question 36

Consider the following Canadian data. Year Inflation rate Unemployment rate
1991 5.60% 10.4%
1992 1.50% 11.3%
1993 1.80% 11.2%
1994 0.20% 10.4%
1995 2.15% 9.5%
1996 1.58% 9.7%
The data suggest

A) no inflation-unemployment relationship
B) an inward shift of the Phillips Curve beginning in 1994
C) an outward shift of the Phillips Curve beginning in 1995
D) a vertical long run Phillips Curve
E) an upward-sloping Phillips Curve

Question 37

Empirically,those nations with the strongest,most independent central banks

A) have the highest sacrifice ratios
B) have the lowest inflation rates
C) have, paradoxically, relied primarily on fiscal policy for stabilization
D) experience longer implementation lags than those with weaker central banks
E) have the most volatile economies