Question 1

A rule that is advocated by the monetarists is the ________ rule.

Accepted Answer

The constant money growth rate rule is advocated by the monetarists, which advocates for a constant rate of growth of the money supply in the economy to stabilize inflation and economic growth.

Question 2

The Lucas critique indicates that ________.

Accepted Answer

The Lucas critique suggests that expectations are important in determining the outcome of a discretionary policy. This is because individuals will adjust their behavior in response to changes in policy, and their expectations of future policy actions will influence how they respond. As a result, policymakers cannot assume that the effects of a particular policy will remain constant over time.

Question 3

The opposite of a discretionary approach is a ________ approach.

Accepted Answer

A discretionary approach relies heavily on the judgment and decision-making of individuals, while a rules-based approach hinges on predetermined guidelines and criteria. Therefore, the opposite of a discretionary approach is a rules-based approach.

Question 4

An example of a rule used in non-discretionary monetary policy is ________.

Accepted Answer

The Taylor rule is an example of a rule used in non-discretionary monetary policy. It prescribes a specific formula for setting the short-term interest rate based on inflation and output gap variables. The central bank must follow the formula, which reduces its discretion in setting policy.

Question 5

Operating with discretion in a monetary policy sense implies ________.

Accepted Answer

Operating with discretion in a monetary policy sense means that central banks are allowed to make decisions based on their assessment of the economic environment, without being constrained by a predetermined policy rule. This allows them to adjust their policy actions in response to changing economic conditions. However, it also means that they are not making any commitments to future actions, as they need to remain flexible in their decision-making process.

Question 6

Today, most economists ________.

Accepted Answer

Most economists today understand that expectations formation can change based on changes in behavior of forecasted variables, which is in line with the Lucas critique. Additionally, many economists still see a role for discretionary stabilization policy, but acknowledge the importance of policy credibility in the success of anti-inflation policy.

Question 7

The interest rate thought to have the most important impact on aggregate demand is the ________.

Accepted Answer

The long-term interest rate is most likely to have the greatest impact on aggregate demand because it affects investment and borrowing decisions for longer-term projects such as home purchases or business investments. Short-term interest rates and rates on shorter-term CDs may have some impact on consumer spending and borrowing, but impact on long-term investment decisions is likely limited. The T-bill rate, while important for government borrowing and lending, may have less impact on private investment and borrowing decisions.

Question 8

The best way to keep inflation under control is to ________.

Accepted Answer

The answer of The best way to keep inflation under...

Question 9

Whether one views the discretionary policies of the 1960s and 1970s as destabilizing or believes the economy would have been less stable without these policies, most economists agree that ________.

Accepted Answer

While opinions differ on the effectiveness of discretionary policies, most economists agree that these policies proved more difficult to implement than anticipated, indicating that stabilization policies were at least somewhat destabilizing.

Question 10

Lucas argues that when policies change, expectations will change thereby ________.

Accepted Answer

Lucas argued that when policies change, the expectations of individuals and firms will also change, which will inevitably alter the relationships in econometric models. Consequently, this could lead to unexpected outcomes, making it difficult to predict the effects of policy changes.

Question 11

The argument that econometric policy evaluation is likely to be misleading if policymakers assume stable economic relationships is known as ________.

Accepted Answer

The argument that econometric policy evaluation is likely to be misleading if policymakers assume stable economic relationships is known as the Lucas critique, named after economist Robert Lucas. It suggests that policy changes can alter economic relationships and create new behavioral patterns, rendering previous models and analysis ineffective. This means that policymakers should be cautious when relying solely on historical data or existing economic relationships to make decisions.

Question 12

According to the Lucas critique, if past increases in the short-term interest rate have always been temporary, then ________.

Accepted Answer

The Lucas critique suggests that relationships observed in historical data, such as the term-structure relationship between short-term and long-term interest rates, may not hold if the underlying economic policy or environment changes. If past increases in the short-term interest rate have always been temporary, the observed effect on the long-term rate might be weak because market participants expect these increases to be reversed, thus having a limited impact on long-term rates.

Question 13

The Lucas critique is an attack on the usefulness of ________.

Accepted Answer

The answer of The Lucas critique is an attack on...

Question 14

The time inconsistency problem means that policy makers are always tempted to pursue ________ policy in the short run.

Accepted Answer

The time inconsistency problem is the tendency of policy makers to prioritize short-term benefits over long-term goals. Therefore, they are more likely to pursue expansionary policies in the short run, even if it leads to higher inflation and other negative consequences in the long run.

Question 15

A policy in which the money supply is kept growing at a constant rate regardless of the state of the economy is ________.

Accepted Answer

A policy in which the money supply is kept growing at a constant rate regardless of the state of the economy is a policy rule advocated by monetarists. This is because monetarists believe that changes in the money supply have a direct impact on inflation and economic activity, and therefore advocate for stable growth of the money supply. A Taylor rule is a specific formula used by central banks to determine the appropriate interest rate based on current economic conditions. A discretionary policy is one in which decisions are made based on the current state of the economy and may vary over time. Advocacy is a term that refers to individuals or groups publicly supporting a particular policy or cause.

Question 16

The Lucas critique highlighted the need for ________.

Accepted Answer

The answer of The Lucas critique highlighted the need for...

Question 17

A rise in short-term interest rates that is believed to be only temporary ________.

Accepted Answer

A rise in short-term interest rates that is believed to be temporary is not likely to have a significant impact on long-term interest rates. This is because long-term interest rates are influenced by a variety of factors beyond just short-term interest rates, such as inflation expectations, economic growth, and geopolitical events. Therefore, a temporary rise in short-term rates is unlikely to cause a major shift in long-term rates.

Question 18

The rational expectations hypothesis implies that when macroeconomic policy changes, ________.

Accepted Answer

The rational expectations hypothesis assumes that people form their expectations based on all available information, including the likely outcomes of policy changes. Therefore, when macroeconomic policy changes, people's expectations will adjust immediately and in a rational manner. This means that the way expectations are formed will change, rather than people making systematic mistakes or being slow to catch on to the change. The economy may or may not become unstable depending on the effectiveness of the policy change and other factors.

Question 19

The time inconsistency problem with respect to policy conduct means ________.

Accepted Answer

The time inconsistency problem with respect to policy conduct refers to the tendency of policymakers to deviate from their long-run plans when making short-term decisions due to various reasons such as political pressure or changing economic conditions. This inconsistency can lead to less effective policies and unstable economic outcomes.

Question 20

Milton Friedman and his followers are known as ________.

Accepted Answer

Milton Friedman and his followers are known as monetarists. They advocate for a monetary policy that focuses on controlling the money supply to achieve macroeconomic goals.

Quiz 25: The Role of Expectations in Monetary Policy