Question 1

The Federal Reserve will keep the inflation rate constant, regardless of evolving economic conditions, if it is using

Accepted Answer

Inflation targeting is a monetary policy framework where the central bank sets an explicit target for the inflation rate and adjusts its policy instruments to try to ensure that this target is achieved. This means that the Federal Reserve would aim to keep the inflation rate constant, regardless of other economic conditions, if it is using inflation targeting. The other options (Friedman's monetary rule, monetary targeting, and the Taylor rule) do not necessarily focus on maintaining a constant inflation rate.

Question 2

An increase in the interest rate causes the aggregate _____ curve to shift _____.

Accepted Answer

An increase in the interest rate makes borrowing more expensive for businesses and consumers, which tends to reduce spending and investment. This decrease in spending and investment causes the aggregate demand curve to shift leftward.

Question 3

Which economists believe that because the economy will always self-adjust, intervention is unnecessary?

Accepted Answer

Classical economists believe that the economy will self-adjust through the invisible hand of the market, and therefore, no intervention is necessary. Monetarists and Fisherites also believe in market forces, but they acknowledge the need for some government intervention in certain situations. Keynesians, on the other hand, believe that government intervention is often necessary to stabilize the economy during periods of recession or inflation.

Question 4

Suppose the monetary authority sets a target of 1% to 2% inflation per year. If the economy experiences deflation, the appropriate monetary policy is

Accepted Answer

Quantitative easing is a form of expansionary monetary policy used to stimulate the economy by increasing the money supply, which can help counteract deflation by encouraging spending and investment.

Question 5

John has $100,000 in annual income but does not own a house or a car. Bob has $100,000 in annual income and owns two houses and four cars. Which theorist would predict that John spends a different proportion of his current income than Bob?

Accepted Answer

Milton Friedman's Permanent Income Hypothesis suggests that people spend money based on their expected long-term average income rather than their current income. Since Bob has more assets, he might perceive a higher permanent income, leading to different spending behavior compared to John.

Question 6

Keynesian monetary analysis relies on changes in interest rates to bring about changes in investment, consumption, and the prices of other assets.

Accepted Answer

Keynesian monetary analysis often relies on changes in interest rates as a mechanism for affecting consumer and investor behavior, as well as influencing inflation and the prices of other assets in the economy.

Question 7

Transparency in Federal Reserve policy

Accepted Answer

Transparency in Federal Reserve policy has become increasingly important in recent years, with the Fed providing regular updates on its decisions and communicating its intentions to the public. This has helped to reduce uncertainty in financial markets, making it easier for investors to make informed decisions and for the Fed to implement more effective monetary policies. While transparency has not always been a hallmark of U.S. monetary policy, it has become increasingly important in recent years.

Question 8

According to the Taylor rule, if the Federal Reserve tries to target inflation near 2%, the inflation rate is 1.5%, and output is 2.3% below potential GDP, the target federal funds rate is 4.4%.

Accepted Answer

The Taylor rule equation is:
Target federal funds rate = neutral real interest rate + inflation rate + (0.5 x inflation gap) + (0.5 x output gap)
Assuming a neutral real interest rate of 2%, and inflation target of 2%, the equation becomes:
Target federal funds rate = 2% + 2% + (0.5 x (2% - 1.5%)) + (0.5 x 2.3%) = 3.65%
Therefore, the correct answer is B.

Question 9

A negative supply shock causes output to _____ and the price level to _____.

Accepted Answer

A negative supply shock, such as an increase in the price of oil or a decrease in productivity, will cause a decrease in output (as firms become less able to produce goods and services) and an increase in the price level (due to the higher costs of production being passed on to consumers). Therefore, choice D is the correct answer.

Question 10

According to monetarist theory, an increase in the money supply will change aggregate spending because people and firms rebalance their portfolios.

Accepted Answer

Monetarist theory suggests that an increase in the money supply will lead to individuals and firms rebalancing their portfolios by buying more goods and services, thereby increasing aggregate spending. This is based on the idea that money is a driving force behind economic activity and that changes in the money supply can have a significant impact on overall economic activity.

Question 11

Classical economists believed that changes in the supply of money translated into changes in the price level.

Accepted Answer

Classical economists, such as Adam Smith, David Ricardo, and John Stuart Mill, believed in the quantity theory of money, which argues that changes in the supply of money directly affect the price level in the long run. According to this theory, an increase in the supply of money leads to a proportional increase in the price level, while a decrease in the supply of money leads to a proportional decrease in the price level.

Question 12

The peak of Internet growth, when new "dot.com" companies sprouted up daily, occurred during

Accepted Answer

The peak of Internet growth and the emergence of new dot.com companies occurred during the 1998-1999 period, which is commonly referred to as the "dot-com bubble." The bubble burst in the early 2000s, leading to a decline in the value of many internet companies and a period of economic recession.

Question 13

The European Central Bank bailed out nearly half of its member countries to prevent the collapse of the euro.

Accepted Answer

The European Central Bank did indeed provide various forms of bailouts to almost half of its member countries in order to stabilize the euro during the financial crisis.

Question 14

The Federal Reserve uses expansionary policy when output is above potential GDP.

Accepted Answer

The Federal Reserve uses contractionary policy when output is above potential GDP to slow down inflationary pressures. Expansionary policy is used when output is below potential GDP to stimulate economic growth.

Question 15

The practice of conducting monetary policy in secret can create uncertainty in markets.

Accepted Answer

Conducting monetary policy in secret can create uncertainty in markets because it can create confusion and speculation about the central bank's intentions and decisions. Transparency and clear communication about monetary policy can help ensure market stability and reduce uncertainty.

Question 16

According to the Taylor rule, if the Federal Reserve tries to target inflation near 2%, the inflation rate is 3%, and output is 1.3% above potential GDP, the target federal funds rate is 6.15%.

Accepted Answer

The Taylor rule suggests that the target federal funds rate should be set at 2% plus the inflation rate plus 0.5 times the output gap. In this case, the inflation rate is 3%, the output gap is 1.3%, so the target federal funds rate should be 6.15%.

Question 17

A supply shock can be due to an increase in the price of oil.

Accepted Answer

A supply shock can occur when there is a sudden change in the availability or cost of production inputs such as oil. An increase in oil prices can lead to higher production costs for many industries, which can result in a decrease in the overall supply of goods and services, causing a supply shock.

Question 18

(Figure: Shifts in Aggregate Demand) Starting at equilibrium point b, if imports increase or consumer demand decreases, the demand curve will shift to _____, thus _____ the price level and _____ real output.

Accepted Answer

If imports increase or consumer demand decreases, aggregate demand will decrease, causing the demand curve to shift to the left from AD to AD' as shown in the graph. This will lead to a decrease in both the price level and real output, moving the economy from point b to point c. The correct curve for this scenario is AD₂.

Question 19

By December 2008, the Federal Reserve had essentially lowered the federal funds target to zero.

Accepted Answer

This is true. The federal funds target rate was lowered to a range of 0%-0.25% by December 2008 in response to the financial crisis.

Question 20

During the last financial crisis, the Federal Reserve was criticized for overstepping its authority and exercising powers it had not been granted. Which of these was NOT one of the causes of this criticism of the Fed?

Accepted Answer

The Federal Reserve was criticized for actions such as buying risky assets, bailing out nonbank institutions, and expanding the monetary base, which could risk future inflation. However, lack of explanation for its actions was not among the primary causes of criticism; the main concerns were about the nature and implications of the actions themselves.

Quiz 13: Monetary Policy