Deck 11: The Is-Mp Model: Adding Inflation and the Open Economy

Question 1

A Phillips curve shows the short-run relationship between

A) potential GDP and real GDP.
B) the nominal interest rate and the real interest rate.
C) tax rates and tax revenues.
D) the unemployment rate and the inflation rate.

Answer 1

D

Question 2

Positive supply shocks can have a tendency to ________ costs of production and ________ the inflation rate.

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

Answer 2

D

Question 3

A decrease in the unemployment rate that is accompanied by an increase in the inflation rate is represented by a ________ the Phillips curve.

A) movement down
B) movement up
C) upward shift of
D) downward shift of

Answer 3

B

Question 4

With adaptive expectations,the expected inflation rate for the current year ________ the actual inflation rate for the previous year.

A) is greater than
B) is less than
C) is equal to
D) is unrelated to

Question 5

The Phillips curve will shift down with ________ or ________.

A) a positive supply shock; an increase in expected inflation
B) a positive supply shock; a decrease in expected inflation
C) a negative supply shock; an increase in expected inflation
D) a negative supply shock; a decrease in expected inflation

Question 6

Positive demand shocks have a tendency to ________ real GDP relative to potential GDP and ________ the inflation rate.

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

Question 7

The Phillips curve will shift up with ________ or ________.

A) a positive supply shock; an increase in expected inflation
B) a positive supply shock; a decrease in expected inflation
C) a negative supply shock; an increase in expected inflation
D) a negative supply shock; a decrease in expected inflation

Question 8

One event that undermined the belief that the Phillips curve represented a structural relationship was

A) the belief of Milton Friedman and Edmund Phelps that expected inflation remains constant.
B) the erratic behaviour of unemployment rates and inflation rates during the 1960s.
C) the extended period of time that both unemployment and inflation remained high during the Great Depression.
D) the increase in both the inflation rate and the unemployment rate in the 1970s.

Question 9

An increase in the unemployment rate that is accompanied by a decrease in the inflation rate is represented by a ________ the Phillips curve.

A) movement down
B) movement up
C) upward shift of
D) downward shift of

Question 10

If the inflation rate in 2013 was 2.5%,and because of that people expect the inflation rate in 2014 will also be 2.5%,these people are said to have

A) rational expectations.
B) expectations of stagflation.
C) adaptive expectations.
D) expectations of supply shocks.

Question 11

Once the Phillips curve has shifted up,the economy is ________ because ________.

A) better off; every unemployment rate becomes associated with a higher inflation rate
B) better off; every inflation rate becomes associated with a lower unemployment rate
C) worse off; every inflation rate becomes associated with a higher unemployment rate
D) worse off; every unemployment rate becomes associated with a lower inflation rate

Question 12

Negative supply shocks can have a tendency to ________ costs of production and ________ the inflation rate.

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

Question 13

Suppose the economy is in equilibrium with an output gap equal to zero and the actual inflation rate equals the expected inflation rate.If the economy experiences a positive demand shock,the output gap will ________ and the inflation rate will ________.

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

Question 14

Economists initially viewed the Phillips curve as a structural relationship,meaning that the relationship between the two measured variables

A) can change only slightly over time.
B) can change greatly over time.
C) will not change over time.
D) will change in the short run but not in the long run.

Question 15

A decrease in the unemployment rate that is accompanied by an decrease in the inflation rate is represented by a(n)________ the Phillips curve.

A) movement down
B) movement up
C) upward shift of
D) downward shift of

Question 16

When the Phillips curve was viewed as a structural relationship,it was believed that the central bank could

A) permanently reduce the unemployment rate if it were willing to accept an increase in the inflation rate.
B) permanently reduce the inflation rate as it permanently reduced the unemployment rate.
C) permanently reduce the unemployment rate if it were willing to increase the real interest rate.
D) permanently reduce the inflation rate if it were willing to decrease the real interest rate.

Question 17

Once the Phillips curve has shifted down,the economy is ________ because ________.

A) better off; every unemployment rate becomes associated with a higher inflation rate
B) better off; every inflation rate becomes associated with a lower unemployment rate
C) worse off; every inflation rate becomes associated with a higher unemployment rate
D) worse off; every unemployment rate becomes associated with a lower inflation rate

Question 18

Negative demand shocks have a tendency to ________ real GDP relative to potential GDP and ________ the inflation rate.

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

Question 19

Once economists take into consideration changes in the expected inflation rate and supply shocks,the Phillips curve

A) only remains useful when explaining the long-run trade-off between unemployment and inflation.
B) remains a useful tool for explaining the short-run trade-off between unemployment and inflation.
C) is no longer a useful tool for explaining any trade-off between unemployment and inflation.
D) accurately explains the short-run and long-run trade-offs between unemployment and inflation.

Question 20

An increase in the unemployment rate that is accompanied by an increase in the inflation rate is represented by a(n)________ the Phillips curve.

A) movement down
B) movement up
C) upward shift of
D) downward shift of

Question 21

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP,and then the economy experiences a negative demand shock.Other things equal,the negative demand shock is best represented by a(n)

A) movement up along the Phillips curve.
B) movement down along the Phillips curve.
C) upward shift of the Phillips curve.
D) downward shift of the Phillips curve.

Question 22

Suppose the economy is in equilibrium with an output gap equal to zero and the actual inflation rate equals the expected inflation rate.If the economy experiences a negative demand shock,real GDP will become ________ potential GDP and the economy will move to the ________ along an existing Phillips curve.

A) greater than; right
B) greater than; left
C) less than; right
D) less than; left

Question 23

Figure 11.1

Refer to Figure 11.1.Assume the economy is in equilibrium at Ȳ₁ = 0.Other things equal,a surge in household wealth will result in a movement from point ________ to point ________.

A) A; B
B) B; A
C) A; C
D) A; D

Question 24

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP.The economy experiences a negative demand shock,and the Bank of Canada responds by decreasing real interest rates to bring real GDP and inflation back to their original levels.Other things equal,the Bank of Canada's response to the negative demand shock is best represented by a movement from

A) point B to point D.
B) point C to point D.
C) point B to point A.
D) point C to point A.

Question 25

Suppose the economy is in equilibrium with an output gap equal to zero and the actual inflation rate equals the expected inflation rate.If the economy experiences a positive demand shock,real GDP will become ________ potential GDP and the economy will move to the ________ along an existing Phillips curve.

A) greater than; right
B) greater than; left
C) less than; right
D) less than; left

Question 26

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP,and then the economy experiences a positive demand shock.Other things equal,the positive demand shock is best represented by a(n)

A) movement up along the Phillips curve.
B) movement down along the Phillips curve.
C) upward shift of the Phillips curve.
D) downward shift of the Phillips curve.

Question 27

Assume the expected inflation for this year was 2%,but the actual inflation turned to be 6%.What are the implications of this unanticipated inflation on:
a) your salary?
b) your student loan?

Question 28

Figure 11.1

Refer to Figure 11.1.Assume the economy is in equilibrium at Ȳ₁ = 0.Other things equal,a decrease in the growth rate of productivity will result in a movement from point ________ to point ________.

A) A; B
B) B; A
C) A; C
D) A; D

Question 29

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP.The economy experiences a positive demand shock,and the Bank of Canada responds by increasing real interest rates to bring real GDP and inflation back to their original levels.Other things equal,the Bank of Canada's response following the positive demand shock is best represented by a(n)

A) movement up along the Phillips curve.
B) movement down along the Phillips curve.
C) upward shift of the Phillips curve.
D) downward shift of the Phillips curve.

Question 30

Assume the economy is in equilibrium at ??= 0,where real GDP equals potential GDP,and the economy experiences a positive demand shock.What policy could the Bank of Canada use to keep the inflation rate from rising? Use the IS-MP model and the Phillips curve to explain your answer.

Question 31

Describe each of the following as a positive demand shock,a negative demand shock,a positive supply shock,or a negative supply shock,and specify how each is represented on the Phillips curve.
a. a sudden increase in oil prices
b. a large increase in spending on residential construction
c. a sudden decrease in household wealth resulting from a stock market crash
d. a substantial increase in productivity following technological advancements

Question 32

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP.The economy experiences a negative demand shock,and the Bank of Canada responds by decreasing real interest rates to bring real GDP and inflation back to their original levels.Other things equal,the Bank of Canada's response following the negative demand shock is best represented by a(n)

A) movement up along the Phillips curve.
B) movement down along the Phillips curve.
C) upward shift of the Phillips curve.
D) downward shift of the Phillips curve.

Question 33

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP.The economy experiences a positive demand shock,and the Bank of Canada responds by increasing real interest rates to bring real GDP and inflation back to their original levels.Other things equal,the positive demand shock is best represented by am initial movement from

A) point A to point B.
B) point A to point C.
C) point D to point B.
D) point D to point C.

Question 34

Suppose the economy is in equilibrium with an output gap equal to zero and the actual inflation rate equals the expected inflation rate.If the economy experiences a negative demand shock,the output gap will ________ and the inflation rate will ________.

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

Question 35

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP.The economy experiences a negative demand shock,and the Bank of Canada responds by decreasing real interest rates to bring real GDP and inflation back to their original levels.Other things equal,the negative demand shock is best represented by a movement from

A) point A to point B.
B) point A to point C.
C) point D to point B.
D) point D to point C.

Question 36

Figure 11.1

Refer to Figure 11.1.Assume the economy is in equilibrium at Ȳ₁ = 0.Other things equal,an unexpected large increase in the price of oil will result in a movement from point ________ to point ________.

A) A; B
B) B; A
C) A; C
D) A; D

Question 37

Figure 11.1

Refer to Figure 11.1.Assume the economy is in equilibrium at Ȳ₁ = 0.Other things equal,a negative demand shock such as the Great Recession would result in a movement from point ________ to point ________.

A) A; B
B) B; A
C) A; C
D) A; D

Question 38

Figure 11.2

Refer to Figure 11.2.Assume the economy is in equilibrium at Ȳ₁,where real GDP equals potential GDP.The economy experiences a positive demand shock,and the Bank of Canada responds by increasing real interest rates to bring real GDP and inflation back to their original levels.Other things equal,the Bank of Canada's response to the positive demand shock is best represented by a movement from

A) point B to point D.
B) point C to point D.
C) point B to point A.
D) point C to point A.

Question 39

What is the Phillips curve? Explain the difference in movements along the Phillips curve and shifts in the Phillips curve,and explain what can cause these movements and shifts.

Question 40

A reason that the inflation rate did not increase substantially following the Great Recession is that

A) the increase in the monetary base was accompanied by larger-than-expected increases in the money supply.
B) the Bank of Canada quickly implemented contractionary fiscal policy to prevent an increase in the inflation rate.
C) the recovery from the recession was slow.
D) the Bank of Canada quickly implemented contractionary monetary policy to prevent an increase in the inflation rate.

Question 41

An increase in the real interest rate outside of Canada will cause net capital outflows to ________ and cause the dollar to ________ relative to other currencies.

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

Question 42

The oil shock of 2007-2008 saw the price of oil rising from less than $60 a barrel in March 2007 to over $145 a barrel in July 2008,and decreasing again to just over $30 a barrel in December 2008.Assuming the economy was at potential GDP prior to the oil shock,the increase in the price of oil,such as what occurred between March 2007 and July 2008,acts as a negative supply shock,resulting in

A) a movement up along the Phillips curve.
B) a movement down along the Phillips curve.
C) an upward shift of the Phillips curve.
D) a downward shift of the Phillips curve.

Question 43

A decrease in the real interest rate outside of Canada will ________ the demand for the dollar and ________ the demand for foreign financial assets.

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

Question 44

The oil shock of 2007-2008 saw the price of oil rising from less than $60 a barrel in March 2007 to over $145 a barrel in July 2008,and decreasing again to just over $30 a barrel in December 2008.Assuming the economy was at potential GDP prior to the oil shock,the increase in the price of oil,such as what occurred between March 2007 and July 2008,acts as a negative supply shock,causing the inflation rate to ________ and the output gap to ________.

A) increase; become negative
B) increase; become positive
C) decrease; become negative
D) decrease; become positive

Question 45

The housing shock that occurred during the Great Recession reduced wealth and residential construction,causing the

A) IS curve to shift to the right.
B) IS curve to shift to the left.
C) MP curve to shift up.
D) MP curve to shift down.

Question 46

Explain three shocks that the Canadian economy experienced during the Great Recession,and how these shocks affect the IS curve,the MP curve,and the Phillips curve.

Question 47

A decrease in the real interest rate outside of Canada will cause the dollar to ________ relative to other currencies and ________ net exports and real GDP.

A) appreciate; increase
B) appreciate; reduce
C) depreciate; increase
D) depreciate; reduce

Question 48

The financial market shock that occurred during the Great Recession increased the default-risk premium,and the housing shock that also occurred during the recession reduced wealth and residential construction.These two events would result in

A) a movement up along the Phillips curve.
B) a movement down along the Phillips curve.
C) an upward shift of the Phillips curve.
D) a downward shift of the Phillips curve.

Question 49

The financial market shock that occurred during the Great Recession increased the default-risk premium,and the housing shock that also occurred during the recession reduced wealth and residential construction.These two events would result in

A) a positive output gap and a rising inflation rate.
B) a negative output gap and a rising inflation rate.
C) a positive output gap and a falling inflation rate.
D) a negative output gap and a falling inflation rate.

Question 50

An increase in the real interest rate in Canada will cause net capital outflows to ________ and cause the dollar to ________ relative to other currencies.

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

Question 51

A decrease in the real interest rate in Canada will cause the dollar to ________ relative to other currencies and ________ net exports and real GDP.

A) appreciate; increase
B) appreciate; reduce
C) depreciate; increase
D) depreciate; reduce

Question 52

Explain the differences between the shocks that the Canadian and United States economies faced during the Great Recession.

Question 53

The oil shock of 2007-2008 saw the price of oil rising from less than $60 a barrel in March 2007 to over $145 a barrel in July 2008,and decreasing again to just over $30 a barrel in December 2008.Assuming the economy was at potential GDP prior to the oil shock,the decrease in the price of oil,such as what occurred between July 2008 and December 2008,acts as a positive supply shock,causing the inflation rate to ________ and the output gap to ________.

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

Question 54

The financial market shock that occurred during the Great Recession increased the default-risk premium,causing the

A) IS curve to shift to the right.
B) IS curve to shift to the left.
C) MP curve to shift up.
D) MP curve to shift down.

Question 55

An increase in the real interest rate in Canada will cause the dollar to ________ relative to other currencies and ________ net exports and real GDP.

A) appreciate; increase
B) appreciate; reduce
C) depreciate; increase
D) depreciate; reduce

Question 56

An increase in the real interest rate outside of Canada will ________ the demand for the dollar and ________ the demand for foreign financial assets.

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

Question 57

An increase in the real interest rate outside of Canada will cause the dollar to ________ relative to other currencies and ________ net exports and real GDP.

A) appreciate; increase
B) appreciate; reduce
C) depreciate; increase
D) depreciate; reduce

Question 58

If the real interest rate in Canada decreases,foreign investors will ________ their demand for Canadian dollars because they desire to ________ fewer Canadian financial assets.

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

Question 59

The oil shock of 2007-2008 saw the price of oil rising from less than $60 a barrel in March 2007 to over $145 a barrel in July 2008,and decreasing again to just over $30 a barrel in December 2008.Assuming the economy was at potential GDP prior to the oil shock,the decrease in the price of oil,such as what occurred between July 2008 and December 2008,acts as a positive supply shock,resulting in

A) a movement up along the Phillips curve.
B) a movement down along the Phillips curve.
C) an upward shift of the Phillips curve.
D) a downward shift of the Phillips curve.

Question 60

If the real interest rate in Canada increases,foreign investors will ________ their demand for Canadian dollars because they desire to ________ more Canadian financial assets.

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

Question 61

Under a fixed exchange rate system,at low domestic real interest rates net capital outflows are ________,so the central bank ________ foreign-exchange reserves.

A) positive; acquires
B) positive; loses
C) negative; acquires
D) negative; loses

Question 62

What happens to the output gap,the real interest rate,and net capital flows with the occurrence of each of the following events? Assume that exchange rates are flexible.
a. The Bank of Canada increases the money supply.
b. Canadian net exports decrease due to a decrease in incomes in the United States.
c. Consumers decide to save more and spend less.
d. Expected profits from newly-built factories in Canada decrease.

Question 63

How does the open-economy IS-MP model incorporate net exports with a floating exchange rate system?

Question 64

A decrease in the real interest rate outside of Canada will cause net capital outflows to ________ and cause the dollar to ________ relative to other currencies.

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

Question 65

Under a fixed exchange rate system,if the government decides to devalue its currency,net exports will ________ and the IS curve will shift to the ________.

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

Question 66

Under a fixed exchange rate system,at high domestic real interest rates the demand for domestic currency ________,so the central bank ________ foreign-exchange reserves.

A) increases; acquires
B) increases; loses
C) decreases; acquires
D) decreases; loses

Question 67

Among the countries that use the euro,the real exchange rate ________ and the nominal exchange rate ________.

A) is fixed; is fixed
B) is fixed; can change
C) can change; is fixed
D) can change; can change

Question 68

A decrease in the real interest rate in Canada will cause net capital outflows to ________ and cause the dollar to ________ relative to other currencies.

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

Question 69

Under a fixed exchange rate system,at low domestic real interest rates the demand for domestic currency ________,so the central bank ________ foreign-exchange reserves.

A) increases; acquires
B) increases; loses
C) decreases; acquires
D) decreases; loses

Question 70

How does the open-economy IS-MP model incorporate net exports with a fixed exchange rate system?

Question 71

Under a fixed exchange rate system,a real interest rate corresponding to the upward-sloping portion of the NCF curve reflects the fact that a central bank ________,and the real interest rate corresponding to the horizontal portion of the NCF curve reflects the fact that a central bank ________.

A) can always supply more domestic currency; can always meet the demand for foreign currency
B) can always supply more domestic currency; is limited in meeting the demand for foreign currency
C) is limited in meeting the demand for domestic currency; can always meet the demand for foreign currency
D) is limited in meeting the demand for domestic currency; is limited in meeting the demand for foreign currency

Question 72

Under a fixed exchange rate system,if the government decides to increase the fixed exchange rate,net exports will ________ and the IS curve will shift to the ________.

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

Question 73

As countries that currently use the euro,what are the two ways that Spain and Greece could reduce the prices of their exports and of their domestic goods to remain competitive with their trading partners?

Question 74

Under a fixed exchange rate system,at high domestic real interest rates net capital outflows are ________,so the central bank ________ foreign-exchange reserves.

A) positive; acquires
B) positive; loses
C) negative; acquires
D) negative; loses