Question 1

The sacrifice ratio is calculated by

Accepted Answer

The sacrifice ratio measures the amount of output lost per percentage point of inflation reduction. It is calculated by dividing the cumulative loss of real GDP (as a percentage of potential GDP) due to disinflation by the number of percentage points by which inflation fell. Choice A is the correct option that represents this calculation.

Question 2

If the unemployment rate is less than the NAIRU,

Accepted Answer

If the unemployment rate is less than the NAIRU, it indicates that the economy is operating above its potential output and there is a shortage of workers. This leads to an increase in demand for workers, which exerts upward pressure on wages. Hence, choice B is correct.

Question 3

The act of "monetary validation" by a central bank can

Accepted Answer

Monetary validation by a central bank typically involves actions that accommodate or support inflationary pressures, potentially perpetuating inflation.

Question 4

In general, the sacrifice ratio will be greater, the

Accepted Answer

The sacrifice ratio is the cost of reducing inflation, which involves short-term costs such as increased unemployment. If it takes a longer time to revise inflationary expectations downwards, then the central bank may need to implement tighter monetary policy for a longer period of time to bring inflation down, which would lead to a higher sacrifice ratio.

Question 5

A contractionary monetary policy that has been imposed to reduce inflation will most likely

Accepted Answer

A contractionary monetary policy is expected to slow down economic growth and reduce inflation. In the short run, it may lead to a recession, but the severity and duration depend on various factors such as the speed of adjustment of inflation expectations and wage rates. If inflation expectations adjust rapidly and accurately to the policy, the recession may be short-lived. Therefore, option D is the correct choice. Options A, B, C, and E are incorrect because they either make unsupported statements or contradict economic theory.

Question 6

Suppose the current inflation rate is 4 percent and the Bank of Canada wants to reduce it to 2 percent, knowing that the sacrifice ratio is 2. Apparently, the Bank of Canada is prepared to accept a decline of real GDP of as the cost of disinflation.

Accepted Answer

The answer of Suppose the current inflation rate is 4...

Question 7

Suppose the NAIRU for Canada is 6 percent, the actual unemployment rate is 7 percent, and productivity is constant. We can conclude that

Accepted Answer

When the actual unemployment rate is higher than the NAIRU, there is an excess supply of labor, which typically puts downward pressure on wages as employers have more potential workers to choose from.

Question 8

When a central bank attempts to stop a sustained inflation, it tries to remove the inflationary gap by

Accepted Answer

The central bank would aim to stop the outward shift of the Aggregate Demand (AD) curve to reduce inflationary pressures, typically by tightening monetary policy, such as raising interest rates.

Question 9

Suppose there is a recessionary gap and the Bank of Canada holds the money supply constant. This scenario will eventually lead to

Accepted Answer

A recessionary gap means that aggregate demand is below potential output, which leads to lower output and employment in the short run. If the Bank of Canada holds the money supply constant, it means that interest rates will not change to stimulate investment and consumption, which will lead to a reduction in wages as businesses will have to lower costs to stay afloat. This will cause a downward shift of the AS curve in the short run. However, in the long run, the economy will adjust and potential output will decrease permanently as firms close down or reduce investment, leading to a lower level of output even if the AS curve shifts back to its original position.

Question 10

Suppose that an increase in world oil prices leads to greater aggregate demand for Canadian exports of oil. If the Bank of Canada reduces the overnight interest rate in response to this increase in AD, this is called

Accepted Answer

Monetary validation occurs when a central bank, like the Bank of Canada, adjusts monetary policy (e.g., reducing interest rates) to accommodate or validate an increase in aggregate demand, such as that caused by higher oil prices.

Question 11

The reason that some economists advise central banks to never validate a negative supply shock is

Accepted Answer

Validating a negative supply shock could entrench expectations of higher inflation, leading workers and firms to demand higher wages and prices to compensate for the increased cost of production. This creates a wage-price spiral, which can lead to higher inflation and reduced economic growth. Therefore, to avoid this possibility, economists advise central banks not to validate negative supply shocks.

Question 12

Which of the following is consistent with constant inflation: expected future inflation of , output- gap inflation of , and supply- shock inflation .

Accepted Answer

Constant inflation implies that the sum of expected future inflation, output-gap inflation, and supply-shock inflation should equal the current inflation rate. In option C, the sum is 2% + 0% + 0% = 2%, which is consistent with constant inflation.

Question 13

A leftward shift in the AD curve accompanied by a leftward shift of the AS curve will

Accepted Answer

A leftward shift in the AD curve reduces aggregate demand, which reduces GDP. A leftward shift in the AS curve reduces aggregate supply, which also reduces GDP. The overall effect on the price level is uncertain, as it depends on the relative magnitudes of the shifts in the AD and AS curves.

Question 14

The process of disinflation can involve some period of increased inflation and reduced output. Economists refer to this as

Accepted Answer

Stagflation is the term used to describe a situation where an economy experiences both high inflation and stagnant economic growth, which can occur during a disinflationary period as the government tries to reduce inflationary pressures.

Question 15

At the end of the 1970s, the inflation rate in Canada had exceeded 10 percent. This high inflation was due mainly to

Accepted Answer

The high inflation rate in Canada in the late 1970s was mainly due to a substantial supply shock caused by a large increase in the world price of oil. This led to higher prices for goods and services, which then led to inflation.

Question 16

A constant inflation in the AD/AS macro model is only possible when

Accepted Answer

Constant inflation in the AD/AS model means that the overall price level is increasing at a steady rate over time. This can only happen when both aggregate demand (AD) and aggregate supply (AS) shift upwards at the same uniform rate. If AD shifts upwards at a faster rate than AS, the result would be inflation with increasing output (demand-pull inflation). If AS shifts upwards at a faster rate than AD, the result would be deflation with decreasing output (cost-push deflation). Therefore, the only option that allows for constant inflation is C, where both AD and AS shift upwards at the same uniform rate.

Question 17

A rightward shift in the AD curve accompanied by a leftward shift of the AS curve will result in

Accepted Answer

A rightward shift in the AD curve increases demand, potentially raising the price level, while a leftward shift in the AS curve decreases supply, also potentially raising the price level. The effect on unemployment is uncertain as the shifts have opposing effects on output.

Question 18

Suppose the NAIRU for Canada is 6.5 percent, and the actual unemployment rate is 5 percent. If the Bank of Canada reduces its target for the overnight interest rate,

Accepted Answer

Reducing the target for the overnight interest rate typically stimulates economic activity, increasing aggregate demand. Since the actual unemployment rate is below the NAIRU, the economy is already in an inflationary gap, and further stimulating demand will worsen this gap.

Question 19

Assume that an economy is currently in long- run equilibrium at its potential output and that it is subjected to a positive demand shock. When the economy moves back to producing its potential level of national income, the price level will be

Accepted Answer

The answer of Assume that an economy is currently in...

Question 20

In general, the sacrifice ratio will be smaller, the

Accepted Answer

The sacrifice ratio is the amount of output that must be sacrificed in the short run in order to bring down inflation in the long run. If it takes a shorter time to revise inflationary expectations downwards, it would mean that inflation expectations can be more easily managed and controlled, resulting in a smaller sacrifice ratio.

Quiz 30: Inflation and Disinflation