Deck 8: Inflation

Question 1

If you had $1,000 in a savings account that paid 4% interest compounded annually, how much would you have in your account after three years?

A)$1,012
B)$1,120
C)$1,125
D)$1,250
E)$1,400

Answer 1

$1,125

Question 2

If inflation were always perfectly anticipated, then

A)its real costs would exactly equal the inflation rate
B)people would hold less cash but would still suffer losses since money balances are always positive
C)the yield on interest-bearing assets would exactly compensate for losses on non-interest bearing assets
D)unemployment would always be at 4 percent
E)wage indexation would not work

Answer 2

people would hold less cash but would still suffer losses since money balances are always positive

Question 3

If inflation this year is higher than expected, then

A)borrowers will gain at the expense of lenders
B)lenders will gain at the expense of borrowers
C)both lenders and borrowers will gain and the government will lose
D)both lenders and borrowers will lose
E)the government will lose unless it has implemented an indexed tax system

Answer 3

borrowers will gain at the expense of lenders

Question 4

Which of the following is TRUE?

A)the costs of unemployment on output are more apparent than the cost of inflation on output
B)the costs of inflation on output are more apparent than the cost of unemployment on output
C)the costs of inflation on output can be measured by Okun's law
D)unanticipated inflation only imposes a cost on currency holders
E)there are no costs to society from anticipated inflation

Question 5

If inflation were always perfectly anticipated and contracts were written in real terms, then

A)there would only be a transfer of wealth from debtors to creditors
B)there would only be a transfer of wealth from creditors to debtors
C)there would only be a transfer of wealth from the poor to the rich
D)there would only be a transfer of wealth from households to firms
E)currency holders would have a negative rate of return

Question 6

If a one-year bond pays a fixed interest rate of 2.5% per year and this year's inflation rate is 2.8%, what is your real rate of return?

A)5)3%
B)2)8%
C)2)5%
D)0)3%
E)-0.3%

Question 7

Which of the following is TRUE, if inflation could be always perfectly anticipated?

A)no costs to society arise from inflation
B)there are no shoe-leather costs
C)there are no menu costs
D)currency holders would not experience any loss of purchasing power
E)none of the above

Question 8

If this year's inflation rate was lower than expected, then

A)a transfer of wealth from the poor to the rich would occur
B)the government would gain tax revenues unless it had an indexed tax system
C)lenders would gain at the expense of borrowers
D)borrowers would gain at the expense of lenders
E)nominal wage rates would increase

Question 9

The concern over inflation

A)is not justified since gains and losses from real wealth transfers cancel out over time for the economy as a whole
B)is irrational since high inflation generally means high growth
C)is attributable primarily to increased transfers arising from cost-of-living adjustments
D)stems from the fact that inflation is rarely predictable and those households who hold fixed dollar assets will experience a loss in wealth
E)none of the above

Question 10

The unanticipated inflation of the last several decades benefited largely

A)elderly people whose major source of income comes from private pension plans
B)lending institutions, especially savings and loans
C)homeowners with fixed mortgage rates
D)taxpayers
E)all of the above

Question 11

The menu cost of inflation arises since

A)people hold less currency if inflation is positive and thus they take more trips to the bank
B)the central bank eventually has to restrict money supply and this causes an increase in the unemployment rate
C)lenders are less likely to give out loans and this has a negative impact on economic activity
D)resources have to be devoted to marking up prices and changing vending machines and cash registers
E)real wages and real money holdings lose purchasing power

Question 12

If you had $4,000 in a savings bank that pays you 2% interest per year, what would be the real value of your savings after 2 years and the yearly inflation rate were 3% per year?

A)$3,959
B)$4,080
C)$4, 162
D)$4,244
E)$4,410

Question 13

If you had $3,000 in a savings account that paid 5% interest compounded annually, how much would you have in your account after five years?

A)$3,484
B)$3,629
C)$3,750
D)$3,829
E)$4,224

Question 14

What interest rate should a banker charge for a loan if she expects that the inflation rate will average about 2.4% over the length of the loan, but wants she a 3% real rate of return?

A)7)2%
B)5)4%
C)3)0%
D)2)4%
E)0)6%

Question 15

A zero inflation target

A)eliminates the short-run unemployment-inflation tradeoff
B)is almost impossible to achieve since it would require an extremely high natural rate of unemployment
C)can only be achieved if wage indexation is implemented nationwide
D)will have much lower costs than an explicit target of achieving a 4% long-term inflation rate
E)may not be as good as a positive inflation target, because it makes it more difficult to achieve full employment

Question 16

When inflation rises unexpectedly, it is generally the case that

A)nominal interest rates and real interest rates will both rise at the same rate
B)nominal interest rates will rise while real interest rates will decline
C)real interest rates will rise while nominal interest rates will decline
D)all nominal wages will immediately be adjusted upwards
E)real wages will have to be adjusted upwards

Question 17

If wages and prices were fully indexed,

A)there would be less inflation following an adverse supply shock
B)inflation could always be perfectly anticipated
C)inflation arising from money expansion could be prevented
D)the economy would have difficulty adjusting to supply shocks since real wages could not adjust easily
E)politicians would be more likely to fight inflation vigorously

Question 18

If the yearly inflation rate could be always be perfectly anticipated, then

A)currency holders would still have a negative rate of return
B)menu costs would still arise
C)people would still have to worry about shoe-leather costs
D)the costs of inflation to society would be small
E)all of the above

Question 19

Which of the following statements is FALSE?

A)homeowners with fixed-rate mortgages benefit from unanticipated high inflation
B)the costs of unanticipated inflation can be ignored, since the gains and losses of induced wealth transfers tend to cancel each other out over the economy as a whole
C)Social Security beneficiaries are better protected against unanticipated inflation than workers with long-term contracts
D)at least until 1985, the U.S. government gained from unanticipated inflation at the expense of U.S. taxpayers
E)workers who received the minimum wage greatly suffered from unanticipated inflation

Question 20

If you had $2,000 in a savings account that paid 4% interest compounded annually, what would be the real value of your savings after two years if the annual inflation rate were 2%?

A)$2,040
B)$2,081
C)$2,160
D)$1,163
E)$2,247

Question 21

In countries where inflation is high and volatile, partial protection from the cost of inflation can be provided by

A)the indexation of debt
B)wage indexation
C)cost-of-living adjustments
D)all of the above
E)none of the above

Question 22

If you lost $1,000 in cash in 2000 and found it again in 2009, the real purchasing power of this cash would have changed by

A)-6.2%
B)-3.8%
C)-3.2%
D)-2.6%
E)-1.8%

Question 23

If your parents promised to give you $1,000 in cash every Christmas for the next 30 years, what would be the real purchasing power of the final $1,000 if the average annual inflation rate over this time period is 3 percent?

A)$820
B)$640
C)$520
D)$410
E)$320

Question 24

The full indexation of wages and prices

A)is widespread in most industrial countries
B)would ensure that each year's inflation rate could always be correctly anticipated
C)would cause some real wage rigidities
D)would greatly help an economy to adjust back to full employment after a supply shock
E)would eliminate all lags between measuring price changes and making wage payments

Question 25

The real return on a bond that pays a fixed interest is equal to

A)the nominal interest rate plus the rate of inflation
B)the nominal interest rate divided by the rate of inflation
C)the nominal interest rate minus the rate of inflation
D)the nominal interest rate times the rate of inflation
E)the interest rate that is stated on the bond

Question 26

An unanticipated increase in inflation is a problem since

A)gains and losses from real wealth transfers cannot be easily predicted
B)higher inflation always means lower growth in real GDP
C)it will lead to a decrease in nominal wages
D)households who hold fixed dollar assets will experience a higher real rate of return
E)none of the above

Question 27

The real return on a ten-year Treasury bond was highest in the period from

A)1960-69
B)1970-79
C)1980-89
D)1990-99
E)2000-09

Question 28

At age 18, you decided to bury $1,000 in your back yard and vowed not to use this money until your planned retirement at age 65.What will be the approximate real purchasing power of this money at that time, assuming that the average annual inflation rate over this time period is 4%?

A)$1,000
B)$960
C)$660
D)$460
E)$160

Question 29

Wage indexation

A)increases nominal wages periodically in accordance with the increase in prices over a given time period
B)helps the economy adjust more rapidly back to the natural unemployment rate after a supply shock
C)is a method of preventing inflation by taxing away what workers may have gained from unanticipated inflation
D)provides protection against purchasing power loss for over half of the U.S. work force
E)is most prevalent n countries with a history of low inflation rates

Question 30

Labor contracts that include so-called COLA provisions

A)tend to link money wages to price increases
B)serve to preserve the purchasing power of workers
C)are a common form of wage indexation in many labor markets
D)often tie nominal wages to a specific price index
E)all of the above

Question 31

When considering the effects of widespread wage indexing

A)one has to distinguish between demand shocks and supply shocks
B)one always comes to the conclusion that they are ill-suited to protect against the loss of purchasing power
C)one quickly realizes the benefits arising from less real wage rate rigidity
D)one realizes that it is very hard to tie nominal wages to a specific price index
E)none of the above

Question 32

If inflation were always completely unanticipated, then

A)the real rate of return on interest-bearing assets could not be easily predicted
B)real interest rates would always be negative
C)menu costs would not occur
D)there would not be a need for wage indexation
E)all of the above

Question 33

The redistribution effect that arises from an unanticipated increase in inflation will affect

A)insurance contracts
B)cash holdings
C)people who own fixed rate bonds
D)all of the above
E)only B and C

Question 34

People should be concerned about imperfectly anticipated inflation since

A)it results in a redistribution of wealth
B)debtors tend to profit while creditors tend to lose
C)equity holders experience a loss in the real value of fixed dividends
D)they may move into higher tax brackets as nominal wages are adjusted for inflation
E)all of the above

Question 35

If you had owned a ten-year Treasury bond from 2000 to 2009, what would have been your real rate of return?

A)0)1%
B)0)9%
C)1)9%
D)2)6%
E)6)2%

Question 36

An unanticipated increase in inflation will lead to a redistribution of wealth but

A)people who hold liquid assets will not suffer any losses
B)will not benefit borrowers in any way
C)will not lead to a change in the real wage rate
D)will not lead to a change in real interest rates
E)none of the above

Question 37

The view that a small positive rate of inflation may actually be good for the economy was first advanced by

A)Ben Bernanke
B)Milton Friedman
C)John Maynard Keynes
D)William Poole
E)James Tobin

Question 38

Economists tend to agree that

A)the best inflation target is a zero percent inflation rate
B)the best inflation target is a two percent inflation rate
C)policy makers should never set inflation targets
D)any inflation target is fine, as long as policy makers announce it in advance
E)it is silly to think that all economists will ever agree on anything

Question 39

An individual can, to some degree, reduce her vulnerability to high and unanticipated inflation by

A)insisting on long-term wage contracts
B)holding long-term bonds
C)holding cash
D)wage indexation
E)all of the above

Question 40

The losses from holding currency were highest in the period from

A)1960-69
B)1970-79
C)1980-89
D)1990-99
E)2000-09

Question 41

In which time period was the average real yield on a ten-year Treasury bond the lowest?

A)1960 to 1969
B)1970 to 1979
C)1980 to 1989
D)1990 to 1999
E)2000 to 2009

Question 42

What was the average real rate of return of three-month Treasury bills during the period of 1970 to 1979?

A)6)9%
B)3)8%
C)2)6%
D)1)2%
E)-0.9%

Question 43

In which time period was the average real yield on a three-month Treasury bill the highest?

A)1960 to 1969
B)1970 to 1979
C)1980 to 1989
D)1990 to 1999
E)2000 to 2009

Question 44

A small amount of inflation may be good for the economy since

A)it will increase nominal GDP
B)there are no menu costs associated with small price adjustments
C)real wage adjustments can be achieved without nominal pay cuts
D)real interest rates will actually increase
E)none of the above

Question 45

Which of the following is FALSE?

A)automatic cost-of-living adjustments in formal labor contracts are common in many countries
B)wage indexation is more prevalent in countries where uncertainty about inflation is high
C)wage indexation is very widespread in the U.S.
D)an unanticipated increase in the inflation rate will increase the government's real tax revenue
E)agovernment bond that is indexed to the price level will have either the interest, the principal, or both adjusted for inflation

Question 46

If people always perfectly anticipated and adjusted to the inflation rate, then

A)real interest rates would be zero
B)there would be no menu costs
C)they would still have to worry about shoe-leather costs
D)the costs of inflation to society would be zero
E)none of the above

Question 47

Generally, the holder of a government bond that is indexed to the price level knows

A)either the interest rate, the principal, or both are adjusted for inflation
B)the real interest rate will fluctuate with inflation
C)there will be no losses as long as inflation is anticipated, but losses can occur if there is an unanticipated increase in the inflation rate
D)all of the above
E)none of the above

Question 48

Which of the following is FALSE, if an increase in the inflation rate cannot be perfectly anticipated?

A)there will be a redistribution of income and wealth
B)debtors will benefit while creditors will lose
C)the holder of an indexed government bond will lose
D)the government will gain real tax revenue
E)the real value of government debt will decline

Question 49

Why are governments so reluctant to adopt widespread wage indexation?

A)it will make it more difficult to adjust to an adverse supply shock
B)widespread wage indexation is very complicated in practice
C)it may result in less political will to fight high inflation
D)all of the above
E)only A and C

Question 50

Assume you financed a new house with a 30-year fixed rate mortgage at a 6% annual interest.rate.If you can deduct your mortgage interest payments from your taxable income and you are in the 30% tax bracket, what would be the real after-tax cost of borrowing if the average annual inflation rate is 4.2% over the 30-years period?

A)+4.2%
B)+1.8%
C)+1.2%
D)0%
E)-1.2%

Question 51

Which of the following is FALSE?

A)wage indexation is widespread in the U.S.
B)the economy will adjust to supply shocks more easily if there is widespread wage indexation
C)the holder of an indexed government bond will lose if an increase in inflation is unanticipated
D)the government loses real tax revenue if there is an unanticipated increase in the inflation rate
E)all of the above