Deck 18: Alternative Views in Macroeconomics

Question 1

If the equation for the quantity theory of money is looked on as a demand-for-money equation, then what does the demand for money depend on? What about the interest rate?

Answer 1

We can conclude that it depends on nominal income but not on the interest rate.

Question 2

What do nearly all economists believe to be true about the origins of inflation over the long run? What does this imply about the Federal Reserve's involvement?

Answer 2

Almost all economists agree that sustained inflation-inflation that continues over many periods-is a purely monetary phenomenon. In the context of the AS/AD framework, inflation cannot continue indefinitely unless the Fed "accommodates" it by increasing the money supply.

Question 3

Identify three beliefs of Keynesian theory regarding the role of government and monetary authorities.

Answer 3

The government has a role to play in fighting unemployment. The government has a role to play in fighting inflation. Monetary and fiscal policies should be used to manage the macroeconomy.

Question 4

Why would time lags between changes in the money supply and its effect on nominal GDP be a factor in measuring the velocity of money? Why would it matter when the velocity o money is measured?

Question 5

What is the equation that the quantity theory of money uses and its assumption?

Question 6

Name two things that Keynes was the first to recognize with respect to the macroeconomy.

Question 7

If the demand for money depends on the interest rate what can we say is true about the velocity of money and the quantity theory of money.

Question 8

What did early economists (i.e. before Keynes) believe about the velocity of money and why did they believe it?

Question 9

Consider a continuously increasing level of government spending (G) without any corresponding increase in taxes. The increases in G keep shifting the AD curve to the right, which leads to an increasing price level (P). (You may find it useful to draw a graph now.) With a fixed money supply, the increases in P lead to a higher and higher interest rate. Why is there a limit to how far this can go?

Question 10

What did early economists believe to be true about the velocity of money and why?

Question 11

Describe the how velocity of money has behaved from 1960 to 2010.

Question 12

If $9 trillion worth of final goods and services are produced in a given year and if the money stock is $3 trillion what is the velocity of money?

Question 13

Write out the equation for the income velocity of money and identify each term.

Question 14

Explain the key concepts of Keynesian economics. Why do Keynesians still support monetary and fiscal policy intervention even though it is clearly not capable of perfectly "fine-tuning" the economy? Define and explain the basic equations of Keynesians and Monetarists. Hint: aggregate expenditures.

Question 15

What does the empirical evidence seem to suggest about the connection between the demand for money and the interest rate?

Question 16

Explain what the velocity of money means.

Question 17

The debate between Keynesians and monetarists was perhaps the central controversy in macroeconomics in the 1960s. The leading spokesman for monetarism was Milton Friedman from the University of Chicago. Where did Friedman put the blame and why?

Question 18

Suppose that the stock of money is $150 billion and nominal GDP is $750 billion. Compute the income velocity of money.

Question 19

What is the principle idea surrounding the Keynesian view of labor markets?

Question 20

Why is it that the quantity theory of money equation is written with a double equal sign instead of the triple equal sign?

Question 21

Suppose that the money supply is $800 billion. If the velocity of money were only to change by .2 percent (without a change in the money supply) how much of a change should that elicit in nominal GDP?

Question 22

Assume the money supply grows by 3 percent. According to the "strict monetarists" view what should be the result? (Hint: M x V = P x Y)

Question 23

Most monetarists argue against an activist monetary policy. Explain why. Explain the type of monetary policy that monetarists do advocate.

Question 24

Contrast the views of Monetarists and Keynesians regarding wage changes.

Question 25

What is required for inflation to be sustained indefinitely?

Question 26

What is one of the main insights of monetarism concerning sustained inflation?

Question 27

Suppose that an increase in the money supply today of 5 percent increases GDP one year from now by precisely 5 percent. How would this time lag effect the empirical measurement of velocity?

Question 28

Why is it difficult to test whether the velocity of money is constant over time?

Question 29

Why is it important which monetary aggregate we choose when testing the stability of velocity?

Question 30

What is sustained inflation? What do most economists believe to be true about its cause?

Question 31

Define the velocity of money. If the demand for money depends on the interest rate, will velocity be constant? Why or why not?

Question 32

Why is it that an increasingly expansionary fiscal policy with no increase in taxes must eventually be accommodated by the Fed in order for it to continue?

Question 33

What policy does Milton Friedman advocate for the Federal Reserve?

Question 34

Explain how the following statements relate to the velocity of money. Assume a constant money supply.
(a) Businesses around the country decide to pay workers only once a month in order to reduce paperwork and improve efficiency.
(b) Banks around the country begin using a new check clearing system that allows checks to clear much faster than they did previously.

Question 35

In 1994 the velocity of money = 3 and the Money Supply = $700 billion. Based on this information answer the following questions. Assume 1994 is the base year.
(a) What are the values of nominal and real GDP for 1994?
(b) If the money supply increases 10% in 1995, what is the effect on nominal GDP, assuming the velocity is constant?
(c) Using the same data from Part (b), if the velocity of money also changes from 3 to 2, now what is the effect on GDP?

Question 36

What do Monetarists believe output is determined by?.

Question 37

After the experience of the 1970s what do most economists believe is true about fiscal and monetary policy tools?

Question 38

Use the quantity theory of money to answer the following questions. We know that for 1994 this small nation had the following economic data: Ms = $200 billion, P = 3, and V = 2. (Assume output = income and GDP = P × Q.)
(a) What is income for 1994? What is nominal GDP?
(b) By how much would the money supply need to change if income were $400 billion?
(c) If annual GDP growth is 5%, by how much will the Ms need to change in 1995? (Use the GDP figure from Part (a).)

Question 39

What is the equation for the quantity theory of money?
(a) If the velocity of money is constant and the economy is at capacity, what impact will an increase in the money supply have?
(b) If the velocity of money is constant and the economy is operating below capacity, what impact will an increase in the money supply have?

Question 40

Assume the Fed increases money supply. In this case, what would the time lag problem of monetary policy due to velocity in the short run.

Question 41

What is the New Classical theoretical critique of the existing macroeconomic models based on?

Question 42

What do traditional macroeconomic models assume about people's expectations of inflation?

Question 43

Assume that households and firms have rational expectations. The current unemployment rate is 7%, which is above the full-employment rate of unemployment. Explain how this can happen. Would you expect this unemployment rate to persist for long? Why or why not?

Question 44

Evaluate the following situations, given a Lucas supply function where Y = 200 + 75(P - Pe), the current price level is 2, and the expected price level is 2.
(a) What happens to output when sudden oil shortages cause the price to increase from 2 to 2.5?
(b) The Federal Reserve was expected to enact a new policy that would have increased the price level from 2 to 2.4, but due to unexpected shocks the price level increased to 2.8. With these changes, what is the effect on output?
(c) The news media found unreported information that inflation would increase considerably under a recent fiscal policy package. What is the effect on output if the media reports to the public that, with this fiscal policy approach, inflation is expected to increase to a level of 3?

Question 45

Identify what occurred in the 1970s that helped motivate the formulation of new classical economics.

Question 46

Refer to the above figure. According to Keynes, what will the impact be in the long run of an expansionary monetary policy after all the adjustments have been made?

Question 47

Refer to the above figure.. According to the new classical economists, what impact on the AD and AS curves would there be under rational expectations of an expected decrease in government spending?

Question 48

Refer to the figure above. According to Keynes, what changes will occur if there is an increase in government spending or an increase in money supply. Explain using the graph.

Question 49

What assumption is made in traditional macroeconomic models about how expectations are formed? Explain the shortcomings of this assumption.

Question 50

Discuss the basis for the rational-expectations hypothesis.

Question 51

What do economists mean when they say that rational expectations are correct on average, even though their predictions are not exactly right all the time?

Question 52

Refer to the above figure. According to the monetarists, a recession can be caused by what movement in the graph above?

Question 53

What criterion should be used for deciding whether or not people are said to have rational expectations?

Question 54

Traditional economic models assume that people form their expectations of future inflation by assuming present inflation will continue and if they are wrong simply adjust their expectations by some fraction of the difference between their original forecast and the actual inflation rate. Why is this not consistent with the assumptions of microeconomics?

Question 55

Refer to the above figure. Suppose the economy is at Point A. According to the rational expectation theory, what impact will an unanticipated increase in money supply have in the short run? Use the figure to answer the question.

Question 56

What is the problem with the traditional macroeconomic treatment of expectations of inflation?

Question 57

Define the rational-expectations hypothesis. Explain the following statement. A rational-expectations theorist argues that all markets, on average, will settle at equilibrium levels.

Question 58

Related to the Economics in Practice on p. 346 [658]: What was the conclusion of the study concerning how people form their expectations?

Question 59

What does the rational-expectations hypothesis suggest about the forecasts that people make concerning future inflation rates?

Question 60

If firms have rational expectations and if they set prices and wages on this basis, then on average what should be true about prices and wages?

Question 61

Assume that the rational-expectations theory is a realistic assumption of how people and firms set their expectations. Indicate the effect of each of the following on the price level and aggregate output.
(a) The Fed announces that it will increase the supply of money.
(b) The government unexpectedly increases government spending.

Question 62

What did early real business cycle theorists emphasize in their work and why do many economists regard it as unsuccessful?

Question 63

Assume that the economy is represented by the following function Y = $9 Trillion + $500 billion (P - P^e). If the current price level is 1.0 and people expect it to rise to 1.1 what will be the new level of GDP if their expectations of inflation are wrong and the actual price level rises to 1.2?

Question 64

According to the Lucas supply function, how will workers react to a positive price surprise? (Assume that the substitution effect is greater than the income effect.)

Question 65

What is the basic policy implication of the Lucas supply function?

Question 66

If tax rates are cut so that people have an increased incentive to work and businesses have an increased incentive to invest, what will be the impact on aggregate supply, aggregate output and the price level?

Question 67

Discuss the principal critiques of the Rational Expectations Theory?

Question 68

Assume that the economy is represented by the following function Y = $9 Trillion + $500 billion (P - P^e) . If the current price level is 1.0 and people expect it to rise to 1.1 what will be the new level of GDP if their expectations of inflation are anticipated correctly?

Question 69

How do rational-expectation theorists explain unemployment?

Question 70

Assume that the economy is represented by the following function Y = $9 Trillion + $500 billion (P - P^e). Furthermore, assume the current price level is 1.0 and policy makers were able to increase the money supply and drive the price level to 1.1 through a secret meeting. What would be the new level of GDP?

Question 71

Write out the Lucas supply function in algebraic terms and identify each component.

Question 72

Describe the Lucas supply function.

Question 73

Explain the impact on real output of a monetary policy change that is announced to the public. Assume rational expectations.

Question 74

Assume that the economy is represented by the following function Y = $9 Trillion + $500 billion (P - P^e). If the current price level is 1.0 and people expect it to rise to 1.2 what will be the new level of GDP if the price level only rises to 1.1?

Question 75

What does real business cycle theory seek to explain?

Question 76

According to the Lucas supply function, how will firms react to a positive price surprise?

Question 77

How is it that rational-expectations theory concludes that on average there will be no unemployment?

Question 78

According to supply-side economists, as tax rates are reduced, labor supply should increase. What does this imply concerning the substitution effect and the income effect?

Question 79

What is the price surprise?

Question 80

Explain the primary argument against the rational-expectations hypothesis. Explain why it is difficult to test whether or not the assumption of rational expectations is valid.