Deck 16: The Dynamics of Inflation and Unemployment

Question 1

Suppose you have $100 to invest for a year and the nominal interest rate is 7 percent. If the inflation rate during the year is 4 percent, at the end of the year your nominal gain from the investment is

A) $3.
B) $4.
C) $7.
D) $11.

Answer 1

$7.

Question 2

In the long run, increases in the growth rate of the money supply will ________ nominal rates of interest and ________ real rates of interest.

A) increase; decrease
B) decrease; decrease
C) increase; not affect
D) decrease; not affect

Answer 2

increase; not affect

Question 3

Which of the following is an example of an expectation of inflation?

A) Producers expect their prices on average to be higher next year.
B) Producers expect the prices they pay for raw materials to be higher next year.
C) Workers expect that the prices they pay for goods and services will be higher next year.
D) all of the above

Answer 3

all of the above

Question 4

Compared to other countries, inflation in the United States has been

A) generally less severe.
B) generally more severe.
C) always worse.
D) about the same.

Question 5

In the short run, decreases in the money supply growth rate will

A) decrease real interest rates.
B) increase real interest rates.
C) may increase or decrease real interest rates.
D) have no effect on real interest rates.

Question 6

Suppose the inflation rate is 3 percent this year. If nominal wages increase by 5 percent, real wages will

A) decrease by 2 percent.
B) increase by 2 percent.
C) increase by 5 percent.
D) decrease by 3 percent.

Question 7

Suppose the inflation rate is 2 percent this year. If nominal wages increase by 5 percent, real wages will

A) decrease by 5 percent.
B) increase by 2 percent.
C) increase by 7 percent.
D) decrease by 3 percent.

Question 8

Suppose workers receive a 5 percent increase in wages and prices are rising by 5 percent. Workers will experience

A) an increase in nominal wages and a decrease in real wages.
B) an increase in nominal wages and an increase in real wages.
C) an increase in nominal wages but real wages are unchanged.
D) a decrease in nominal wages and a decrease in real wages.

Question 9

In the long run, decreases in the growth rate of the money supply will ________ nominal rates of interest and ________ real rates of interest.

A) decrease; increase
B) decrease; decrease
C) increase; increase
D) decrease; not affect

Question 10

If nominal wages increase by 5 percent while real wages fall by 1 percent, the inflation rate must be

A) 1 percent.
B) 4 percent.
C) 5 percent.
D) 6 percent.

Question 11

When the expected rate of inflation is added to the real interest rate, the result is called the

A) preferred rate.
B) nominal interest rate.
C) adjustment rate.
D) differential rate.

Question 12

All else equal, if workers confuse real and nominal magnitudes, they are experiencing

A) expectations of inflation.
B) money illusion.
C) monetary confusion.
D) fiscal policy.

Question 13

In the short run, increases in the money supply growth rate will

A) decrease real interest rates.
B) increase real interest rates.
C) may increase or decrease real interest rates.
D) have no effect on real interest rates.

Question 14

Suppose the inflation rate is 6 percent this year. If nominal wages increase by 6 percent, real wages will

A) increase by 6 percent.
B) increase by 9 percent.
C) decrease by 12 percent.
D) not change.

Question 15

The real rate of interest is defined as the

A) expected inflation rate minus the nominal interest rate.
B) expected inflation rate plus the nominal interest rate.
C) nominal interest rate minus the expected inflation rate.
D) nominal inflation rate plus the expected inflation rate.

Question 16

Suppose you have $100 to invest for a year and the nominal interest rate is 7 percent. If the inflation rate during the year is 4 percent, at the end of the year your real gain from the investment is approximately

A) $3.
B) $4.
C) $7.
D) $11.

Question 17

If nominal wages increase by 6 percent while real wages increase by 4 percent, the inflation rate must be

A) 2 percent.
B) 4 percent.
C) 6 percent.
D) 10 percent.

Question 18

The United States had serious difficulties fighting inflation in

A) the 1970s.
B) the 1980s.
C) both the 1970s and the 1980s.
D) every decade since World War II.

Question 19

In the long run, decreases in the money supply will

A) decrease real interest rates.
B) increase real interest rates.
C) may increase or decrease real interest rates.
D) have no effect on real interest rates.

Question 20

If nominal wages increase by 4 percent while real wages remain constant, the inflation rate must be

A) -2 percent.
B) 0 percent.
C) 2 percent.
D) 4 percent.

Question 21

When the public expects inflation, real and nominal interest rates will differ because inflation needs to be accounted for in calculating the real return from lending and borrowing.

Question 22

Suppose the economy has been at full employment for the past two years with a 7 percent inflation rate, and both the money supply and money demand were growing at 7 percent a year. If the Federal Reserve unexpectedly decreases the rate of money growth to 3 percent, the following sequence of events occurs

A) real interest rates fall, investment spending decreases, GDP increases, unemployment falls, and prices rise.
B) real interest rates rise, investment spending decreases, GDP decreases, unemployment increases, and prices fall.
C) real interest rates fall, investment spending increases, GDP increases, unemployment falls, and prices rise.
D) real interest rates rise, investment spending increases, GDP decreases, unemployment increases, and prices fall.

Question 23

In the short run, increases in the growth rate of the money supply will ________ nominal rates of interest and ________ real rates of interest.

A) decrease; increase
B) increase; decrease
C) decrease; decrease
D) increase; increase

Question 24

Suppose the public expects a 4 percent inflation rate, while the Federal Reserve unexpectedly allows the money growth rate to be 5 percent. In the short run, we expect that

A) real interest rates will remain constant.
B) real interest rates may increase or decrease.
C) real interest rates will decrease.
D) real interest rates will increase.

Question 25

An economy can, in principle, produce at full employment with any inflation rate.

Question 26

Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. Suddenly the Federal Reserve unexpectedly allows the money growth rate to be 4 percent. In the short run, we expect that investment spending by firms will ________ and consumer durable spending will ________.

A) decrease; decrease
B) increase; decrease
C) decrease; increase
D) increase; increase

Question 27

All else equal, expectations of higher inflation will affect the amount of money people are holding because they will need more cash to pay for goods and services.

Question 28

In the long run, the real rate of interest does not depend on monetary policy but the nominal rate of interest does.

Question 29

Suppose the public expects a 4 percent inflation rate, while the Federal Reserve unexpectedly allows the money growth rate to be 5 percent. In the short run, we expect that investment spending by firms will ________ and consumer durable spending will ________.

A) decrease; decrease
B) increase; decrease
C) decrease; increase
D) increase; increase

Question 30

All else equal, nominal wages would not likely increase if there is no inflation.

Question 31

In the short run, decreases in the growth rate of the money supply will ________ nominal rates of interest and ________ real rates of interest.

A) decrease; increase
B) increase; decrease
C) decrease; decrease
D) increase; increase

Question 32

Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. The Federal Reserve decides to keep the the money growth rate to be 7 percent. In the short run, we expect that investment spending by firms will ________ and consumer durable spending will ________.

A) increase; decrease
B) decrease; increase
C) increase; increase
D) None of the above; there will be no change in the level of investment spending by firms and consumer durable spending by households.

Question 33

Suppose the economy has been at full employment for the past two years with a 4 percent inflation rate, and both the money supply and money demand were growing at 4 percent a year. If the Federal Reserve unexpectedly increases the rate of money growth to 6 percent, the following sequence of events occurs

A) real interest rates fall, investment spending increases, GDP increases, unemployment falls, and prices rise.
B) real interest rates fall, investment spending decreases, GDP increases, unemployment falls, and prices rise.
C) real interest rates rise, investment spending decreases, GDP decreases, unemployment increases, and prices fall.
D) real interest rates rise, investment spending increases, GDP decreases, unemployment increases, and prices fall.

Question 34

When the public expects inflation, real and nominal rates of interest will be the same.

Question 35

When people expect inflation, they assume that prices are going to increase at a certain rate and factor this into their decision making.

Question 36

Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. Suddenly the Federal Reserve unexpectedly allows the money growth rate to be 5 percent. In the short run, we expect that

A) real interest rates will remain constant.
B) real interest rates may increase or decrease.
C) real interest rates will decrease.
D) real interest rates will increase.

Question 37

A tight-money policy in the short run typically leads to

A) slower money growth.
B) higher interest rates.
C) lower output.
D) all of the above

Question 38

Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. The Federal Reserve decides to keep the money growth rate at 7 percent. In the short run, we expect that

A) real interest rates will remain constant.
B) real interest rates may increase or decrease.
C) real interest rates will decrease.
D) real interest rates will increase.

Question 39

The real interest rate is the nominal interest rate plus the expected inflation rate.

Question 40

In the long-run, reduced money growth results in ________ while having no effect on the level of output.

A) lower inflation and lower unemployment
B) lower interest rates and lower inflation
C) lower interest rates and less purchasing of durable goods
D) higher interest rates and no change in inflation

Question 41

A decrease in the inflation rate is likely to be associated with

A) an increase in the unemployment rate.
B) decreased unemployment benefits.
C) a decreased in the unemployment rate.
D) less unemployment benefits being paid.

Question 42

By making more or less money available, the Federal Reserve can alter both the nominal and real interest rates in the long run.

Question 43

Suppose workers negotiate for a 5 percent nominal wage increase and expect a 1 percent inflation rate. If the actual inflation rate is 6 percent, then workers

A) and firms are both better off.
B) are better off and firms are worse off.
C) are worse off and firms are better off.
D) and firms are both worse off.

Question 44

According to the rational expectations theory

A) the public makes consistent errors when forming expectations.
B) only central bankers form expectations rationally.
C) the public, on average, anticipates the future correctly.
D) the public only uses a portion of the available information when forming expectations.

Question 45

Assume that last year's inflation rate is the same as the expectation of inflation for the next year. According to the expectations Phillips curve, if the inflation rate decreases relative to the expected rate, the unemployment rate

A) decreases.
B) increases.
C) may increase or decrease.
D) does not change.

Question 46

Increases in unanticipated inflation will impact employment levels, but once workers recognize higher inflation rates, they will incorporate them into their expectations of inflation. This will tend to cause

A) unemployment to fall below the natural rate.
B) unemployment to return to its natural rate.
C) the natural rate of unemployment to rise.
D) the natural rate of unemployment to fall.

Question 47

Define "money illusion" and explain its cause.

Question 48

Increases in unanticipated inflation will impact employment levels and would therefore tend to cause

A) unemployment to rise above the natural rate.
B) the natural rate of unemployment to rise.
C) unemployment to fall below the natural rate.
D) the natural rate of unemployment to fall.

Question 49

Assume that last year's inflation rate is the same as the expectation of inflation for the next year. According to the expectations Phillips curve, if the inflation rate increases relative to the expected rate, the unemployment rate

A) decreases.
B) increases.
C) may increase or decrease.
D) does not change.

Question 50

If the inflation rate unexpectedly increases, it is likely that workers will not fully anticipate some of this sudden increase. This will tend to cause nominal wages to ________ and the belief that real wages have ________.

A) increase; increased
B) increase; decreased
C) decrease; increased
D) decrease; decreased

Question 51

If the public forms their expectations rationally, a credible central bank will

A) tend to encourage wage increases.
B) tend to deter wage increases.
C) have no influence over wages.
D) ignore the public's beliefs.

Question 52

Explain why real and nominal rates of interest will differ when the public expects inflation.

Question 53

If the rate of unemployment is equal to the natural rate, the rate of inflation will

A) fall by 1 percent per year
B) rise by 1/2 percent per year.
C) fall by 1/2 percent per year.
D) not change.

Question 54

Assume that last year's inflation rate is the same as the expectation of inflation for the next year. According to the expectations Phillips curve, if the inflation rate remains constant relative to the expected rate, the unemployment rate

A) decreases.
B) increases.
C) may increase or decrease.
D) does not change.

Question 55

Explain why money demand will be affected when the public expects inflation.

Question 56

The difference between the Phillips curve and the expectations Phillips curve is that the

A) expectations Phillips curve takes into account expectations of inflation.
B) Phillips curve takes into account expectations of inflation.
C) Phillips curve is flatter.
D) Phillips curve is steeper.

Question 57

If the inflation rate unexpectedly increases, it is likely that workers will not fully anticipate some of this sudden increase. This will cause

A) anticipated inflation to exceed actual inflation.
B) actual inflation to exceed anticipated inflation.
C) anticipated inflation to equal actual inflation.
D) nominal inflation to exceed real inflation.

Question 58

If the growth rate of money changes, there will be no long-run effects on real interest rates.

Question 59

If the growth rate of money changes, there will be short-run effects on real interest rates.

Question 60

According to the expectations Phillips curve, unemployment varies with

A) unanticipated inflation.
B) anticipated inflation.
C) actual inflation.
D) real inflation.

Question 61

In order to reduce the high inflation of the late 1970s, Paul Volcker

A) increased the growth of the money supply, thereby decreasing interest rates.
B) decreased the growth of the money supply, thereby decreasing interest rates.
C) decreased the growth of the money supply, thereby increasing interest rates.
D) increased the growth of the money supply, thereby increasing interest rates.

Question 62

Suppose that the expected inflation rate is 3 percent and the actual inflation rate is 6 percent. Then borrowers

A) and lenders are both better off.
B) are better off and lenders are worse off.
C) are worse off and lenders are better off.
D) and lenders are both worse off.

Question 63

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
Recall the Application. If the natural rate of unemployment has been underestimated and is actually higher than is commonly perceived, reducing the unemployment rate to the perceived natural rate will tend to

A) increase anticipated inflation.
B) decrease anticipated inflation
C) increase unanticipated inflation.
D) decrease unanticipated inflation.

Question 64

As the result of unanticipated inflation, lenders are better off while borrowers are worse off if the actual inflation rate

A) is equal to the expected inflation rate.
B) exceeds the expected inflation rate.
C) is less than the expected inflation rate.
D) Neither borrowers nor lenders are better off as the result of unanticipated inflation.

Question 65

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
Recall the Application. Under normal circumstances, the higher the unemployment rate, the ________ job vacancies there will be. Over time, this would tend to ________ the natural rate of unemployment.

A) more; increase
B) more; decrease
C) fewer; increase
D) fewer; decrease

Question 66

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
If the natural rate of unemployment was 5 percent and inflation was 3 percent, the inflation rate will rise if the unemployment rate for the next two years rose to 8 percent.

Question 67

As the result of unanticipated inflation, borrowers are better off while lenders are worse off if the actual inflation rate

A) exceeds the expected inflation rate.
B) is equal to the expected inflation rate.
C) is less than the expected inflation rate.
D) Neither borrowers nor lenders are better off as the result of unanticipated inflation.

Question 68

Which of the following would likely lead to an increase in the natural rate of unemployment?

A) an increase in the number of teenagers in the workforce
B) an increase in the length of time during which people can receive unemployment benefits
C) a prolonged recession
D) all of the above

Question 69

During the Carter administration, inflation increased from 6.5 percent to 9.4 percent because

A) unemployment increased above the natural rate.
B) the economy experienced an oil price shock.
C) The United States was involved in a major war.
D) the Fed suspended the dollar's convertibility into gold.

Question 70

Suppose that the expected inflation rate is 8 percent and the actual inflation rate is 8 percent. Then borrowers

A) and lenders are both worse off.
B) and lenders are both better off.
C) are better off and lenders are worse off.
D) none of the above

Question 71

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
According to the Application, the natural rate of unemployment in the United States was approximately 5 percent in the mid 1960s, ________ in the late 1970s and early 1980s, and ________ in the late 1980s until the year 2000.

A) peaked; declined
B) rose; continued to rise
C) fell; rose again
D) remained at 5 percent; began to rise

Question 72

As the result of unanticipated inflation, firms are better off while workers are worse off if the actual inflation rate

A) is equal to the expected inflation rate.
B) exceeds the expected inflation rate.
C) is less than the expected inflation rate.
D) Neither firms nor workers are better off as the result of unanticipated inflation.

Question 73

Suppose workers negotiate for a 5 percent nominal wage increase and expect a 8 percent inflation rate. If the actual inflation rate is 4 percent, then workers

A) and firms are both better off.
B) are better off and firms are worse off.
C) are worse off and firms are better off.
D) and firms are both worse off.

Question 74

During the early 1980s, one effect of the Federal Reserve's fight against inflation was

A) historically low interest rates.
B) falling unemployment rates.
C) the largest peace-time economic expansion.
D) high unemployment rates.

Question 75

Which of the following would be likely to lead to a decrease in the natural rate of unemployment?

A) an increase in the number of teenagers in the workforce
B) a decrease in the length of time during which people can receive unemployment benefits
C) a prolonged recession
D) all of the above

Question 76

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
According to the theory of rational expectations, people do not make mistakes when they form their expectations.

Question 77

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
According to the Application, if the labor market becomes more efficient in matching jobs with individuals, there will be ________ job vacancies and the natural rate of unemployment will ________.

A) more; rise
B) more; decline
C) fewer; rise
D) fewer; decline

Question 78

Recall the Application about how to estimate the shifts in the natural rate of unemployment to answer the following question(s).
According to the expectations Phillips curve, the unemployment rate and the inflation rate are inversely related.

Question 79

As the result of unanticipated inflation, workers are better off while firms are worse off if the actual inflation rate

A) is equal to the expected inflation rate.
B) exceeds the expected inflation rate.
C) is less than the expected inflation rate.
D) Neither firms nor workers are better off as the result of unanticipated inflation.

Question 80

Suppose that the expected inflation rate is 4 percent and the actual inflation rate is 1 percent. Then borrowers

A) and lenders are both better off.
B) are better off and lenders are worse off.
C) are worse off and lenders are better off.
D) and lenders are both worse off.