Question 1

Describe the immediate short-run effect to the economy from an increase in government purchases, as well as the self-correcting mechanism that will restore long-run equilibrium.

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Question 2

Use the long-run model presented in Chapter 22 to answer this question.If there is a decrease in aggregate demand, and monetary policymakers counter the decrease in aggregate demand, what will be the impact on output and inflation? Explain.

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Question 3

Where would the economy be operating relative to the dynamic aggregate demand curve, the short-run aggregate supply curve and the long-run aggregate supply curve, if the economy is experiencing an expansionary gap?

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Question 4

If monetary policymakers are more concerned about output fluctuations than inflation fluctuations:
A)they will choose a relatively steep monetary policy reaction curve in which movements in the real interest rates are small.
B)they will choose a relatively flat monetary policy reaction curve in which movements in the real interest rates are small.
C)they will choose a relatively steep monetary policy reaction curve in which movements in the real interest rates are large.
D)they will choose a relatively flat monetary policy reaction curve in which movements in the real interest rates are large.

Accepted Answer

If policymakers are more concerned about output fluctuations than inflation, they will choose a relatively flat monetary policy reaction curve in order to keep real interest rates relatively stable, as large movements in real interest rates could create further output fluctuations. This means that changes in inflation will have a smaller impact on interest rates compared to changes in output, indicating a greater focus on stabilizing the economy.

Question 5

Monetary policymakers face a tradeoff between:
A)the level of output and the rate of inflation.
B)the volatility in output and the volatility in inflation.
C)low unemployment and high inflation.
D)high unemployment and low inflation.

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A)the level...

Question 6

When faced with negative supply shocks, policymakers:
A)will stabilize both inflation and output.
B)will always focus on stabilizing output.
C)cannot stabilize output so they tend to focus on inflation.
D)face a trade-off because they cannot simultaneously stabilize both output and inflation.

Accepted Answer

Negative supply shocks, such as a sudden increase in oil prices or a natural disaster that disrupts production, lead to a decrease in aggregate supply, causing both inflation and output to increase. Policymakers face a trade-off between stabilizing inflation and stabilizing output, as they cannot do both simultaneously. If policymakers focus on stabilizing output by using expansionary policies, such as lowering interest rates or increasing government spending, it may lead to higher inflation. On the other hand, if policymakers focus on stabilizing inflation by using contractionary policies, such as raising interest rates or reducing government spending, it may lead to lower output. Therefore, policymakers must weigh the costs and benefits of each policy to find the best solution to stabilize both inflation and output in the long run.

Question 7

Neutralizing demand shocks is easier in theory than in practice.Why?

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Question 8

Why do negative supply shocks pose a particularly difficult dilemma for monetary policymakers?

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Question 9

Explain why changes in the central bank's inflation target will shift the dynamic aggregate demand curve.

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Question 10

Discuss the short-and long-run output responses resulting from an increase in money growth when the economy is producing a current level of output that equals potential output, all other factors constant.

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Question 11

In 2001 a combination of tax cuts and increased defense spending did not have the same inflationary effect as the similar policy in the 1960s.Explain the difference.

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Question 12

If monetary policymakers do not want the current inflation rate to increase, yet they observe increasing aggregate demand from higher government purchases, will they have to accept a higher inflation target? Explain.

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Question 13

Why does it take so long for the declaration of the beginning and end of recessions in the U.S.and why is there a lack of clarity as to what is and is not a recession?

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Question 14

Why could it be effectively argued that the temporary increase in inflation from the spending for the Vietnam War was made permanent by the Fed?

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Question 15

Which of the following is true?
A)A flat dynamic aggregate demand curve corresponds to a steep monetary policy reaction curve and means that supply shocks will create large changes in current output.
B)A flat dynamic aggregate demand curve corresponds to a flat monetary policy reaction curve and means that supply shocks will create large changes in current output.
C)A flat dynamic aggregate demand curve corresponds to a steep monetary policy reaction curve and means that supply shocks will create small changes in current output.
D)A flat dynamic aggregate demand curve corresponds to a flat monetary policy reaction curve and means that supply shocks will create small changes in current output.

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A)A flat...

Question 16

In which situation will inflation fall the fastest?
A)A negative supply shock occurs, the dynamic aggregate demand curve is steep and so is the monetary policy reaction curve
B)A negative supply shock occurs, the dynamic aggregate demand curve is flat and so is the monetary policy reaction curve
C)A negative supply shock occurs, the dynamic aggregate demand curve is flat, and the monetary policy reaction curve is steep
D)A negative supply shock occurs, the dynamic aggregate demand curve is steep, and the monetary policy reaction curve is flat

Accepted Answer

In this scenario, the flat dynamic aggregate demand curve indicates that changes in output will have limited effects on prices. Additionally, the steep monetary policy reaction curve suggests that the central bank will take strong action to counteract any inflationary pressures, which will ultimately lead to a faster decrease in inflation.

Question 17

Why can monetary policymakers neutralize demand shocks but not supply shocks?

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Question 18

Explain why understanding short-run fluctuations in output and inflation requires that we study shifts in dynamic aggregate demand and short-run aggregate supply.

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Question 19

Central bankers with a relatively flat monetary policy reaction curve will:
A)move interest rates more aggressively when inflation rises, leading to more volatility in output.
B)move interest rates more aggressively when inflation rises, leading to less volatility in output.
C)move interest rates less aggressively when inflation rises, leading to more volatility in output.
D)move interest rates less aggressively when inflation rises, leading to less volatility in output.

Accepted Answer

Central bankers with a relatively flat monetary policy reaction curve are more willing to tolerate inflation in order to avoid instability in output. Therefore, they will move interest rates less aggressively when inflation rises, leading to less volatility in output.

Question 20

Describe a scenario where a negative supply shock (that raises the rate of inflation) results in a permanently higher rate of inflation.

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Quiz 22: Understanding Business Cycle Fluctuations