Question 1

The Taylor Rule states that the

Accepted Answer

The Taylor Rule suggests that the Federal Reserve (Fed) should adjust the federal funds rate based on deviations of inflation from its target level and deviations of real GDP from potential GDP. This approach aims to stabilize the economy by controlling inflation and smoothing out the business cycle.

Question 2

Suppose that the equilibrium real interest rate is 2 percent per year, inflation is 2.5 percent and the output gap is 1 percent. Using the Taylor rule, what is the federal funds rate?

Accepted Answer

The Taylor rule formula is: Federal Funds Rate = Equilibrium Real Interest Rate + Current Inflation + 0.5(Output Gap) + 0.5(Inflation Gap). Here, the inflation target is not given, but typically, a 2% target is assumed, making the inflation gap 0.5% (2.5% - 2%). Plugging in the numbers: Federal Funds Rate = 2 + 2.5 + 0.5(1) + 0.5(0.5) = 5.25%.

Question 3

-In the above figure, the economy experiences an increase in aggregate demand so that the aggregate demand curve shifts from AD₀ to AD₂. If the Fed wants to offset this change, it would

Accepted Answer

To offset an increase in aggregate demand, the Federal Reserve (Fed) would aim to decrease the money supply and increase interest rates to dampen spending and investment. Selling government securities on the open market is a tool used to achieve this by taking cash out of circulation, which aligns with option B.

Question 4

The Fed's actions to fight an inflation shift the

Accepted Answer

The Fed fights inflation by reducing the money supply or raising interest rates, which decreases overall spending and investment. This leads to a leftward shift in the aggregate demand curve, as consumers and businesses reduce spending.

Question 5

-Which aggregate supply-aggregate demand diagram above shows the effect on real GDP and the price level of monetary policy when it is used to fight a recession?

Accepted Answer

Monetary policy used to fight a recession typically involves increasing the money supply, which shifts the aggregate demand curve to the right, increasing real GDP and the price level. Figure A likely shows this effect.

Question 6

In the short run, a rise in the federal funds rate ________ the price level and ________ real GDP.

Accepted Answer

A rise in the federal funds rate typically leads to higher interest rates overall, which can decrease spending and investment. This reduction in demand can lower the price level and decrease real GDP in the short run.

Question 7

One problem with the ripple effect from the Fed's monetary policy is

Accepted Answer

The ripple effect from the Fed's monetary policy can be problematic because the transmission process of monetary policy is long and drawn out, meaning it takes time for policy changes to have their intended effects on the economy.

Question 8

If the Fed follows the Taylor rule and the economy goes into a recession, the Fed would

Accepted Answer

The Taylor rule suggests that the Federal Reserve (Fed) should adjust the federal funds rate in response to changes in inflation and the output gap. During a recession, the output gap is negative (actual output is below potential output), so according to the Taylor rule, the Fed would lower the federal funds rate to stimulate economic activity. Reducing tax rates and increasing government expenditures are fiscal policy measures, not actions typically taken by the Fed.

Question 9

An inflation rate targeting rule

Accepted Answer

An inflation rate targeting rule helps to reduce uncertainty about monetary policy by providing a clear and transparent framework for monetary policy decisions, which can help anchor inflation expectations.

Question 10

In the short run, the Fed's actions to fight an inflationary gap shift the

Accepted Answer

To combat an inflationary gap, the Federal Reserve (Fed) would typically increase interest rates or use other contractionary monetary policies. These actions would decrease overall spending in the economy, leading to a leftward shift of the aggregate demand curve.

Question 11

Suppose that initially real GDP equals potential GDP. Then an increase in aggregate demand occurs. According to the Taylor rule, the Fed should ________ the federal funds rate by ________ government securities in the open market.

Accepted Answer

When aggregate demand increases, it can lead to inflationary pressures. According to the Taylor rule, the Federal Reserve should respond by raising the federal funds rate to cool down the economy. The Fed raises the federal funds rate by selling government securities in the open market, which decreases the money supply and increases interest rates.

Question 12

A worldwide recession reduces the amount of U.S. exports, and as a result, aggregate demand decreases. To move U.S. GDP back to potential GDP, the Fed should

Accepted Answer

Lowering the federal funds rate would decrease interest rates, encouraging borrowing and spending, which in turn would increase aggregate demand and help move GDP back to potential GDP.

Question 13

In the short run, a rise in the federal funds rate shifts the

Accepted Answer

A rise in the federal funds rate typically leads to higher interest rates overall, which can reduce spending on investment and consumption. This decrease in spending shifts the Aggregate Demand (AD) curve leftward, indicating a decrease in the total demand for goods and services in the economy.

Question 14

Which of the following is a problem in pursuing monetary policy?

Accepted Answer

The statements A, B, and C are incorrect regarding the problems in pursuing monetary policy. The lag between a change in the quantity of money and its effect on economic activity is often considered too long rather than too short, making timely adjustments challenging. Monetary policy decisions, including adjustments to the federal funds rate, are made by the Federal Reserve (the Fed) and do not require approval by Congress. The Fed can indeed influence the federal funds rate through open market operations and other tools.

Question 15

-In the above figure, suppose point C is the original equilibrium. If the Fed increases the federal funds rate, the new equilibrium is given by point

Accepted Answer

Increasing the federal funds rate typically leads to higher interest rates, reducing investment and consumer spending, which shifts the aggregate demand curve leftward, moving the equilibrium to point A.

Question 16

The Taylor rule uses three variables to determine the target for the federal funds rate. Which of the following is NOT one of those variables?

Accepted Answer

The Taylor rule does not use the monetary base as one of its variables. It uses the equilibrium real interest rate, the inflation rate, and the output gap to determine the appropriate federal funds rate.

Question 17

Suppose that initially real GDP equals potential GDP. Then a decrease in aggregate demand occurs. According to the Taylor rule, the Fed should ________ the federal funds rate by ________ government securities in the open market.

Accepted Answer

When there is a decrease in aggregate demand, the economy might face lower inflation and higher unemployment. According to the Taylor rule, the Federal Reserve should lower the federal funds rate to stimulate the economy. Lowering the federal funds rate is achieved by buying government securities in the open market, which increases the money supply and encourages spending and investment.

Question 18

The Taylor rule

Accepted Answer

The Taylor rule is a guideline for how central banks like the Federal Reserve should adjust interest rates in response to changes in economic conditions, specifically inflation and the output gap. It does not exclusively focus on real GDP fluctuations nor ignore price level stability, and it is not the exact rule followed by the Fed, though it influences monetary policy decisions.

Question 19

Suppose that the inflation rate is 3 percent and the output gap is -1 percent. Assuming that the equilibrium real interest rate is 2 percent, what target should the Fed set for the federal funds rate, if the Taylor rule is used?

Accepted Answer

The Taylor rule formula is: Federal Funds Rate = Equilibrium Real Interest Rate + Inflation Rate + 0.5(Output Gap) + 0.5(Inflation Gap). Here, Inflation Gap is zero (assuming target inflation is 3%). So, 2% + 3% + 0.5(-1%) = 5%.

Question 20

-In the above figure, the economy experiences a decrease in aggregate demand so that the aggregate demand curve shifts from AD₀ to AD₁. If the Fed wants to offset this change, it would

Accepted Answer

To offset a decrease in aggregate demand, the Federal Reserve (Fed) can purchase government securities on the open market. This action increases the money supply, lowers interest rates, and stimulates borrowing and spending, which can help to increase aggregate demand back to its original level.

Quiz 14: Monetary Policy

The Taylor Rule states that the

Suppose that the equilibrium real interest rate is 2 percent per year, inflation is 2.5 percent and the output gap is 1 percent. Using the Taylor rule, what is the federal funds rate?

-In the above figure, the economy experiences an increase in aggregate demand so that the aggregate demand curve shifts from AD₀ to AD₂. If the Fed wants to offset this change, it would

The Fed's actions to fight an inflation shift the

-Which aggregate supply-aggregate demand diagram above shows the effect on real GDP and the price level of monetary policy when it is used to fight a recession?

In the short run, a rise in the federal funds rate the price level and real GDP.

One problem with the ripple effect from the Fed's monetary policy is

If the Fed follows the Taylor rule and the economy goes into a recession, the Fed would

An inflation rate targeting rule

In the short run, the Fed's actions to fight an inflationary gap shift the

Suppose that initially real GDP equals potential GDP. Then an increase in aggregate demand occurs. According to the Taylor rule, the Fed should the federal funds rate by government securities in the open market.

A worldwide recession reduces the amount of U.S. exports, and as a result, aggregate demand decreases. To move U.S. GDP back to potential GDP, the Fed should

In the short run, a rise in the federal funds rate shifts the

Which of the following is a problem in pursuing monetary policy?

-In the above figure, suppose point C is the original equilibrium. If the Fed increases the federal funds rate, the new equilibrium is given by point

The Taylor rule uses three variables to determine the target for the federal funds rate. Which of the following is NOT one of those variables?

Suppose that initially real GDP equals potential GDP. Then a decrease in aggregate demand occurs. According to the Taylor rule, the Fed should the federal funds rate by government securities in the open market.

The Taylor rule

Suppose that the inflation rate is 3 percent and the output gap is -1 percent. Assuming that the equilibrium real interest rate is 2 percent, what target should the Fed set for the federal funds rate, if the Taylor rule is used?

-In the above figure, the economy experiences a decrease in aggregate demand so that the aggregate demand curve shifts from AD₀ to AD₁. If the Fed wants to offset this change, it would

Quiz 14: Monetary Policy

The Taylor Rule states that the

Suppose that the equilibrium real interest rate is 2 percent per year, inflation is 2.5 percent and the output gap is 1 percent. Using the Taylor rule, what is the federal funds rate?

-In the above figure, the economy experiences an increase in aggregate demand so that the aggregate demand curve shifts from AD0 to AD2. If the Fed wants to offset this change, it would

The Fed's actions to fight an inflation shift the

-Which aggregate supply-aggregate demand diagram above shows the effect on real GDP and the price level of monetary policy when it is used to fight a recession?

In the short run, a rise in the federal funds rate ________ the price level and ________ real GDP.

One problem with the ripple effect from the Fed's monetary policy is

If the Fed follows the Taylor rule and the economy goes into a recession, the Fed would

An inflation rate targeting rule

In the short run, the Fed's actions to fight an inflationary gap shift the

Suppose that initially real GDP equals potential GDP. Then an increase in aggregate demand occurs. According to the Taylor rule, the Fed should ________ the federal funds rate by ________ government securities in the open market.

A worldwide recession reduces the amount of U.S. exports, and as a result, aggregate demand decreases. To move U.S. GDP back to potential GDP, the Fed should

In the short run, a rise in the federal funds rate shifts the

Which of the following is a problem in pursuing monetary policy?

-In the above figure, suppose point C is the original equilibrium. If the Fed increases the federal funds rate, the new equilibrium is given by point

The Taylor rule uses three variables to determine the target for the federal funds rate. Which of the following is NOT one of those variables?

Suppose that initially real GDP equals potential GDP. Then a decrease in aggregate demand occurs. According to the Taylor rule, the Fed should ________ the federal funds rate by ________ government securities in the open market.

The Taylor rule

Suppose that the inflation rate is 3 percent and the output gap is -1 percent. Assuming that the equilibrium real interest rate is 2 percent, what target should the Fed set for the federal funds rate, if the Taylor rule is used?

-In the above figure, the economy experiences a decrease in aggregate demand so that the aggregate demand curve shifts from AD0 to AD1. If the Fed wants to offset this change, it would

-In the above figure, the economy experiences an increase in aggregate demand so that the aggregate demand curve shifts from AD₀ to AD₂. If the Fed wants to offset this change, it would

In the short run, a rise in the federal funds rate the price level and real GDP.

Suppose that initially real GDP equals potential GDP. Then an increase in aggregate demand occurs. According to the Taylor rule, the Fed should the federal funds rate by government securities in the open market.

Suppose that initially real GDP equals potential GDP. Then a decrease in aggregate demand occurs. According to the Taylor rule, the Fed should the federal funds rate by government securities in the open market.

-In the above figure, the economy experiences a decrease in aggregate demand so that the aggregate demand curve shifts from AD₀ to AD₁. If the Fed wants to offset this change, it would