Archimedean Upper Conservatory Economics, November 2016 Quiz, Unit VI, Stabilization Policies

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1 Multiple Choice Identify the choice that best completes the statement or answers the question. 1. The federal budget tends to move toward _ as the economy. A. deficit; contracts B. deficit; expands C. surplus; contracts D. a balanced budget; contracts E. a balanced budget; expands 2. The government budget balance equals: A. Taxes + Government purchases + Government transfers. B. Taxes Government purchases Government transfers. C. Taxes Government purchases + Government transfers. D. Taxes + Government purchases Government transfers. E. Government transfers - Taxes + Government purchases. 3. When the budget is in deficit, the government generally: A. raises taxes. B. increases the public debt. C. sells public assets like national parks. D. decreases military spending. E. increases transfer payments. 4. When government decides to increase taxes in order to fight an inflationary gap, this is: A. most likely to increase the size of the budget deficit. B. an example of discretionary fiscal policy. C. an example of an automatic stabilizer. D. likely to dampen the effects of inflation, but will not lead to a correction. E. an example of monetary policy. 5. Government spending that results in persistent deficits, government borrowing, and a reduction in private investment is referred to as: A. implicit liabilities. B. transfer payments. C. trade deficits. D. automatic stabilizers. E. crowding out. 6. During an expansion, economists generally believe that an economy should: A. balance its budget. B. run a budget deficit. C. run a budget surplus. D. be able to pay off all of its debt. E. see rising levels of unemployment.

2 Figure 31-1: Money Market I 7. Use the Money Market I Figure If the money market is initially in equilibrium at point E and the central bank _ bonds, then the interest rate will: A. sells; move toward point H. B. sells; move toward point L. C. buys; remain at point E. D. sells; remain at point E. E. buys; move toward point H. 8. Suppose the Fed sells bonds. We can expect this transaction to: A. decrease the money supply, increase bond prices, and decrease interest rates. B. increase the money supply, decrease bond prices, and decrease interest rates. C. increase the money supply, increase bond prices, and decrease interest rates. D. decrease the money supply, decrease bond prices, and increase interest rates. E. decrease the money supply, increase bond prices, and increase interest rates. 9. To expand the money supply, the Federal Reserve would have to do which of the following? A. Engage in an open market purchase of Treasury bills. B. Engage in an open market sale of Treasury bills. C. Raise interest rates. D. Get approval from Congress. E. Increase the discount rate. 10. According to the liquidity preference model, what will happen to the money supply curve, the equilibrium interest rate, and the equilibrium quantity of money, if the Fed sells Treasury bonds in an open market operation? A. Money Supply Curve shifts leftward, Interest Rate increases, Quantity of Money decreases B. Money Supply Curve shifts leftward, Interest Rate increases, Quantity of Money increases C. Money Supply Curve shifts leftward, Interest Rate decreases, Quantity of Money decreases D. Money Supply Curve shifts rightward, Interest Rate increases, Quantity of Money decreases E. Money Supply Curve shifts rightward, Interest Rate decreases, Quantity of Money increases

3 11. In the income-expenditure model, contractionary monetary policy causes: A. a decrease in interest rates, an increase in planned investment spending, and an increase in equilibrium GDP. B. a decrease in interest rates, a decrease in planned investment spending, and a decrease in equilibrium GDP. C. an increase in interest rates, an increase in planned investment spending, and an increase in equilibrium GDP. D. an increase in interest rates, a decrease in planned investment spending, and a decrease in equilibrium GDP. E. an increase in interest rates, a decrease in planned investment spending, and a increase in equilibrium GDP. Figure 31-3: The Money Supply and Aggregate Demand 12. Use the The Money Supply and Aggregate Demand Figure Panel (b) illustrates what happens when the Fed decides to the money supply and interest rates. A. decrease; decrease B. increase; increase C. increase; decrease D. decrease; increase E. increase; hold constant 13. Use the The Money Supply and Aggregate Demand Figure If the economy is experiencing an inflationary gap, the Fed would government bonds, which would the money supply and interest rates. This is shown in Panel. A. buy; increase; decrease; (a) B. sell; decrease; increase; (b) C. buy; decrease; increase; (b) D. sell; increase; increase; (b) E. buy; increase; decrease; (b)

4 Figure 31-6: Monetary Policy II 14. Use the Monetary Policy II Figure Starting from short-run equilibrium at Y 2, sound central bank policy would be: A. contractionary monetary policy to fight high inflation. B. expansionary monetary policy to fight high unemployment. C. neutral to increase LRAS. D. balanced to fight high inflation. E. contractionary monetary policy to fight high unemployment. 15. Monetary neutrality implies that in the long run: A. monetary policy does not affect the level of economic activity. B. aggregate supply is independent from monetary policy. C. changing the money supply does not have any effect on the aggregate price level. D. aggregate demand is independent from monetary policy. E. monetary policy is effective at increasing long-run aggregate supply. 16. If the Fed conducts an open market purchase, holding everything else constant: A. in the long run, there will be an increase in the aggregate price level. B. in the long run, there will be an increase in the aggregate output level. C. in the long run, there will be a decrease in unemployment. D. in the long run, there will be no effects on output, unemployment, or the price level. E. in the long run, there will be a decrease in potential GDP. 17. In the long run, an increase in aggregate demand from a position of full employment leads to: A. higher prices and higher output. B. higher prices and no change in output. C. higher output and lower prices. D. higher output and higher unemployment. E. lower prices and no change in output.

5 Figure 32-3: AD AS 18. Use the AD AS Figure Refer to the AD AS diagram. Suppose the economy is initially at E 1, and then moves to E 2 where AD 2 intersects SRAS 1. Now, suppose that the SRAS 1 shifts to SRAS 2, because: A. real wages rise in the long run. B. nominal wages rise in the long run. C. the real money supply rises in the long run. D. aggregate real output rises in the long run. E. nominal wages fall in the long run. 19. The inflation tax is: A. the increase in the real value of money held by the public caused by inflation. B. the decrease in the real value of money held by the public caused by inflation. C. the result of the indexing wages to inflation. D. cost of living adjustments, or COLAS. E. the increase in income taxes caused by inflation. 20. Monetizing the debt occurs when: A. the budget is approved by Congress. B. the Fed buys back debt via open market purchases. C. the government raises taxes. D. transfer payments are decreased. E. the trade deficit is reduced to zero. 21. When inflation is high: A. people will increase their level of real money holdings. B. people will save more. C. lenders gain at the expense of borrowers. D. people will decrease their level of real money holdings. E. real wages will increase.

6 22. If the natural rate of unemployment is 5%, and the actual rate of unemployment is 4%: A. disinflation is likely to occur. B. there will be no effect on prices. C. inflation will increase. D. the short-run Phillips curve will shift down. E. deflation is likely to occur. Figure 34-1: Expected Inflation and the Short-Run Phillips Curve SRPC 0 is the Phillips curve with an expected inflation rate of 0%; SRPC 2 is the Phillips curve with an expected inflation rate of 2%. 23. Use the Expected Inflation and the Short-Run Phillips Curve Figure Suppose that this economy currently has an unemployment rate of 6%, inflation of 2%, and has an expectation of 2% future inflation. If the central bank increases the money supply such that aggregate demand shifts to the right and unemployment falls to 4%, then inflation would: A. decrease to 2%. B. not change. C. increase to 2%. D. increase to 4%. E. increase to 6%. 24. Use the Expected Inflation and the Short-Run Phillips Curve Figure Suppose that this economy currently has an unemployment rate of 6%, inflation of 2%, and has an expectation of 2% future inflation. If the central bank decreases the money supply such that aggregate demand shifts to the left and unemployment rises to 8%, then inflation would: A. decrease to 0%. B. not change. C. increase to 2%. D. increase to 4%. E. decrease to -2%. 25. Suppose that the economy experiences an increase in the unemployment rate at the same time that the inflation rate declines. This situation would be consistent with a movement along the: A. vertical Phillips curve. B. horizontal Phillips curve. C. positively sloped Phillips curve. D. negatively sloped Phillips curve. E. vertical long-run AS curve.

7 26. The short-run Phillips curve: A. is upward rising because inflation and unemployment rates have a positive relationship in the short run. B. is vertical because there is no trade-off between inflation and unemployment rates in the short run. C. is downward sloping because there is a trade-off between inflation and unemployment rates in the short run. D. is horizontal because there is no trade-off between inflation and unemployment rates in the short run. E. is downward sloping because there is a trade-off between interest rates and investment in the short run. 27. Suppose you are told that there has been a downward movement along the fixed short-run Phillips curve. Which of the following must have happened? A. The AD curve has shifted to the left. B. The AD curve has shifted to the right. C. The SRAS curve has shifted to the left. D. The SRAS curve has shifted to the right. E. The LRAS curve has shifted to the right. 28. Suppose that commodity prices across the economy begin to fall and consumers and firms begin to expect a lower rate of future inflation. What do we expect to happen to the SRAS curve and short-run Phillips curve? A. The SRAS curve will shift to the left, and the short-run Phillips curve will shift downward. B. The SRAS curve will shift to the right, and the short-run Phillips curve will shift downward. C. The SRAS curve will shift to the left, and the short-run Phillips curve will shift upward. D. The SRAS curve will shift to the right, and the short-run Phillips curve will shift upward. E. The LRAS curve will shift to the right, and the short-run Phillips curve will shift upward.

8 Figure 34-2: Short-Run Phillips Curve 29. Use the Short-Run Phillips Curve Figure SRPC 1 is based on an expected inflation rate of: A. 0%. B. 1%. C. 2%. D. 3%. E. 5%. 30. As a consequence of the existence of a non-accelerating-inflation rate of unemployment, or NAIRU: A. cyclical unemployment can never be zero. B. there is no short-run tradeoff between unemployment and inflation. C. money is neutral. D. in the long run, unemployment can be equal to zero. E. there is no long-run tradeoff between unemployment and inflation. 31. When workers and firms become aware of a rise in the general price: A. they will not do anything, because they know they are powerless to counter any economic changes. B. they will negotiate lower prices of goods, services, and wages. C. firms with sticky prices will ultimately adjust their prices downward. D. they will agree to renegotiate wage contracts downward. E. they will incorporate higher prices into their expectations of future prices. 32. Disinflation is so costly to the economy, because if: A. a deflation is forced on the economy, employment decreases and aggregate output falls. B. a high inflation is forced on the economy, unemployment decreases and aggregate price level increases. C. a stagflation is forced on the economy, unemployment increases and inflation increases. D. a recession is forced on the economy, unemployment increases and aggregate output falls. E. a recession is forced on the economy, unemployment decreases and aggregate output falls.

9 Scenario 34-1: Effects of Deflation The nominal interest rate is 7% on a 1-year loan for $1,000. The lender had anticipated an inflation rate of 2% for the coming year. During the year, however, the economy experienced deflation of 4%. 33. Use Scenario After one year, the borrower must repay: A. $1,110. B. $1,070. C. $1,050. D. $1,030. E. $ Use Scenario In this case: A. the borrower is hurt and the lender is helped by deflation. B. the borrower is helped and the lender is hurt by deflation. C. there is no benefit or harm either to the borrower or the lender. D. the effects on the borrower and the lender depend on their respective tax rates. E. both the borrower and lender are hurt by deflation. 35. A liquidity trap is a situation in which: A. using expansionary monetary policy is not effective, because the real interest rate is negative. B. aggregate demand falls, because consumers do not have enough liquidity to consume. C. using expansionary monetary policy is not effective because, the nominal interest rate is almost zero. D. lenders are trapped by large loans with declining rates of return. E. using expansionary fiscal policy is not effective because, the budget is in a deficit. 36. To avoid falling into a liquidity trap, most central banks: A. seek a positive, but small, inflation rate rather than zero inflation. B. target inflation, rather than the money supply. C. conduct open-market operations to change the money supply, instead of changing the discount rate. D. aim at a target of zero inflation, so that inflation expectations are zero, too. E. prefer to engage in expansionary, rather than contractionary, monetary policy. 37. If an economy's short-run Phillips curve shifts up, this is most likely due to: A. a change in the inflation rate. B. an increase in the unemployment rate. C. an increase in expected inflation. D. a contractionary fiscal policy. E. an expansionary fiscal policy. 38. In the classical model of the price level, prices are _, and the short-run aggregate supply curve is vertical. As a result, a decrease in the money supply leads to _ in the aggregate price level. A. sticky; a more than proportional decrease B. flexible; an equal proportional decrease C. sticky; a more than proportional increase D. flexible; an equal proportional increase E. flexible; a less than proportional decrease

10 39. Classical economists point out that: A. there is a trade-off between unemployment and inflation. B. an increase in the money supply leads to an equal proportional rise in the price level. C. government spending can affect aggregate demand. D. there is the possibility of a liquidity trap. E. monetary policy can increase potential GDP. 40. A fundamental feature of early classical macroeconomics is that: A. aggregate demand and aggregate income are usually unequal. B. prices of inputs and outputs are usually relatively rigid. C. the economy's level of employment can remain substantially below its natural level over a prolonged period of time. D. the economy can achieve full employment on its own, though there could be temporary periods in which employment falls below the natural level. E. expansionary monetary policy can increase aggregate output without inflation. 41. Keynesian economics emphasizes shifts in aggregate. A. long-run; demand B. long-run; supply C. short-run; demand D. short-run; supply E. long-run; supply and demand 42. Which one of the following statements is TRUE? A. Keynes treated short-run macroeconomics as a minor issue. B. Keynes emphasized the short-run effects of shifts in aggregate demand on aggregate output, employment, and prices whereas the classical economists focused on the long-run determination of the aggregate price level. C. The classical economists believed that the short-run aggregate supply curve was upward sloping. D. The classical economists emphasized the short-run effects of shifts in aggregate demand on aggregate output, whereas Keynes focused on the long-run determination of the aggregate price level. E. Keynes saw no role for the government in affecting the business cycle. 43. According to Keynes, the remedy for a recessionary gap was straightforward. The solution was to: A. increase aggregate supply. B. increase aggregate demand. C. control big business. D. decrease government involvement. E. wait for the economy to self-correct. Scenario 35-2: The Quantity Theory of Money Suppose the money supply is equal to $10 billion and the velocity of money is Use Scenario Refer to the information provided. If the aggregate price level is 4, then the real GDP is: A. $60 billion. B. $30 billion. C. $20 billion. D. $15 billion. E. $10 billion.

11 Figure 35-2: Fiscal Policy with a Fixed Money Supply 45. Use the Fiscal Policy with a Fixed Money Supply Figure Assume that this economy is at E 2. Now government deficit spending is decreased, but the Federal Reserve expands the money supply. According to this model: A. real GDP will decrease just as much as it would if the Federal Reserve had not expanded the money supply. B. real GDP will decrease, but not as much as it would if the Federal Reserve had failed to expand the money supply. C. real GDP will expand, but not as much as it would if the Federal Reserve had not expanded the money supply. D. interest rates will increase. E. this combination of fiscal and monetary policy will crowd out private investment spending. 46. Monetarists argue that: A. the impact lag for monetary policy is short and predictable. B. stabilization policies may actually be destabilizing. C. the Federal Reserve System should use active monetary policy. D. active monetary policy should be used to reinforce active fiscal policy. E. the money supply should be fixed in the long run. 47. The _ hypothesis has been almost universally accepted among modern economists. This hypothesis is that macroeconomic policy should used be to stabilize the economy, as opposed to any attempt to permanently decrease the unemployment rate. A. natural rate B. political business cycle C. rational expectations D. real business cycle E. Phillips

12 48. The Friedman Phelps natural rate. hypothesis made a strong prediction: A. that once inflation gets embedded in people's expectation, the unemployment and inflation will have a trade-off. B. that the unemployment and inflation trade-off will not exist once inflation gets embedded in people's expectation. C. that there will always be an unemployment and inflation trade-off. D. that the unemployment and inflation trade-off is a myth. E. that there is a trade-off between unemployment and inflation during recessions, but not during expansions. 49. The set of ideas known as the New Keynesian economics states that: A. markets clear in the short run because prices adjust whenever there are surpluses or shortages. B. market imperfections tend to make prices sticky in the short run. C. markets tend to be in equilibrium because of the inherent forces in the economy. D. wage-price inflation is the main problem that most economies face in the short run. E. Competitive markets tend to make prices flexible in the short run. 50. Classical economists believed that: A. wages and prices were inflexible, and as a result, the aggregate supply curve was vertical. B. wages and prices were inflexible, and as a result, the aggregate demand curve was vertical. C. wages and prices were flexible, and as a result, the aggregate demand curve was vertical. D. wages and prices were flexible and as a result, the aggregate supply curve was vertical. E. wages and prices were flexible and as a result, the aggregate supply curve was upward sloping. 51. For Keynes, changes in aggregate demand had their greatest impact: A. on the aggregate price level. B. in the long run. C. on the aggregate output level. D. equally on the aggregate output level and the aggregate price level. E. on the real interest rate. 52. Monetarists believe that: A. short-run problems are not likely to occur. B. GDP fluctuations will be less pronounced if the Federal Reserve uses discretionary monetary policy. C. price fluctuations are likely to occur in the short or long runs. D. GDP will grow steadily if the money supply grows steadily E. GDP will grow steadily if government spending grows steadily. 53. A monetary policy rule: A. occurs when the central bank pursues a formula that determines its actions. B. results in the introduction of political impacts into the monetary policy process. C. is the same as discretionary monetary policy. D. is likely to be advocated by Keynesians. E. is likely to be advocated by classical economists.

13 54. Using increased government spending and tax cuts to fight a recession is consistent with which of the following schools of thought? A. classical B. classical and monetarist C. classical and Keynesian D. Keynesian and the modern consensus E. Keynesian and monetarist 55. The modern consensus about macroeconomic policy is that: A. only monetary policy works against recessions but fiscal policy is effective only in the long run. B. both expansionary monetary and fiscal policies can reduce unemployment in the long run. C. both expansionary monetary and fiscal policies are effective in the short run but not in the long run. D. discretionary monetary and fiscal policies are effective in the short run and in the long run. E. discretionary monetary and fiscal policies are effective in the long run, but not in the short run.