Question 1

The loans that ended up in the hands of low-risk borrowers were called subprime loans.

Accepted Answer

The loans that ended up in the hands of high-risk borrowers were called subprime loans.

Question 2

Indexing protects parties against unanticipated price increases by writing contracts that automatically change the prices of goods or services.

Accepted Answer

Indexing allows for automatic price adjustments based on predetermined factors such as inflation, protecting parties from unexpected price increases.

Question 3

The Taylor rule is a complete discretionary policy.

Accepted Answer

The Taylor rule is not a complete discretionary policy, but rather a guideline for setting the target federal funds rate based on inflation and output. It allows for some discretion in adjusting the rate to reflect other factors, but it is not completely discretionary in the sense that the central bank can choose any rate it wants without adhering to a specified framework.

Question 4

Assuming wages are indexed to inflation, if prices rose by 1.4 percent this month and your last month's wage was $1,000, your wage this month would be $1,014.

Accepted Answer

If wages are indexed to inflation, they would increase by the same percentage as the rise in prices. Therefore, a 1.4 percent increase in prices would result in a 1.4 percent increase in wages, which would bring the wage to $1,014.

Question 5

Automatic stabilizers are not regarded as important fiscal policies.

Accepted Answer

Automatic stabilizers refer to government policies or programs that automatically adjust to the economic conditions and help stabilize the economy without the need for explicit action. These include policies like unemployment benefits and progressive income taxes. Automatic stabilizers are considered important fiscal policies because they help reduce the severity of economic fluctuations without requiring constant adjustments from policymakers.

Question 6

Inflation targeting may lead to a liquidity trap.

Accepted Answer

Inflation targeting involves setting a target for a specific inflation rate and adjusting monetary policy to achieve that target. However, if the economy experiences a recession or deflationary pressures, the central bank may push interest rates very low in order to stimulate borrowing and spending. This can create a situation where people and businesses hoard cash instead of spending it, and the extra liquidity in the system does not translate into increased economic activity. This is known as a liquidity trap, and it can be a risk when using inflation targeting as a monetary policy tool.

Question 7

If policy makers' ability to forecast the future is limited, their ability to stabilize the economy with fiscal and monetary policy is compromised.

Accepted Answer

If policy makers cannot accurately forecast the future, they may not be able to implement timely and effective fiscal and monetary policies to stabilize the economy.

Question 8

When expansionary policy is anticipated, it leads to a short-run expansion in output and employment.

Accepted Answer

The answer of When expansionary policy is anticipated, it leads...

Question 9

When the economy operates at levels significantly lower than the full-employment level, input prices are flexible.

Accepted Answer

When the economy operates at levels significantly lower than the full-employment level, input prices, especially wages, tend to be sticky downwards due to contracts, minimum wage laws, and workers' resistance to pay cuts, making them less flexible.

Question 10

Critics of inflation targeting argue that central banks need flexibility.

Accepted Answer

Critics argue that inflation targeting can be too rigid and may not take into account changing economic conditions or unexpected events, and thus there is a need for central banks to have flexibility in their monetary policy decisions.

Question 11

If people respond quickly to policy changes that imply future inflation will increase, the short run aggregate supply curve will shift upward due to their changed expectations.

Accepted Answer

When people respond quickly to policy changes that imply future inflation will increase, they adjust their expectations of future prices and wages. This means that businesses will also adjust their prices and wages upward in anticipation of higher costs in the future. As a result, the short run aggregate supply curve will shift upward to reflect the higher costs of production in the economy.

Question 12

The crowding-out effect occurs when household consumption and investment spending increase as a result of a decrease in the demand for money.

Accepted Answer

The crowding-out effect occurs when an increase in government spending leads to a decrease in private-sector spending, particularly investment spending. This typically occurs when the government borrows funds to finance its spending, which increases the demand for money and drives up interest rates, making it more costly for businesses and households to borrow and spend. This means that the crowding-out effect is actually the opposite of the scenario described in the question - it's not a result of a decrease in the demand for money, but rather an increase in it due to government spending.

Question 13

Critics of targeting a zero inflation rate believe that achieving zero inflation is almost impossible and the costs are too high.

Accepted Answer

Critics argue that achieving a zero inflation rate is difficult as there are many factors that can influence inflation such as global economic trends, natural disasters, and government policies. Additionally, the costs of maintaining a zero inflation rate may outweigh the benefits as it can require a strict monetary policy and limit economic growth.

Question 14

It is easier to adopt an economic policy when a recession is caused by a supply shock rather than a demand shock.

Accepted Answer

Supply shocks often involve sudden changes in the availability of a commodity or service (such as oil), making it more challenging for policymakers to adjust economic policies effectively. In contrast, demand shocks, which affect the overall demand for goods and services, can often be more directly addressed through fiscal and monetary policy adjustments.

Question 15

Before the global economic crisis, the United States had discouraged the mortgage industry by raising lending standards for low-income families.

Accepted Answer

Before the global economic crisis, the United States had encouraged the mortgage industry by lowering lending standards for low-income families as part of their efforts to increase homeownership rates. This led to a housing bubble that eventually burst, causing the global economic crisis.

Question 16

The rational expectations theory suggests that government or central bank policies designed to change aggregate demand will be effective.

Accepted Answer

Rational expectations theory suggests that individuals and firms use all available information to form expectations about economic variables and policies, thus often neutralizing the intended effects of government or central bank policies designed to change aggregate demand.

Question 17

A positive supply shock causes a leftward shift in the short-run aggregate supply curve.

Accepted Answer

A positive supply shock actually causes a rightward shift in the short-run aggregate supply curve, as it leads to an increase in the amount of goods and services that can be produced at any given price level.

Question 18

The problem of time lags in making policy changes is less acute for monetary policy than it is for fiscal policy.

Accepted Answer

Monetary policy changes can be implemented relatively quickly through the actions of central banks, while fiscal policy changes often require legislative action and may face political obstacles and delays.

Question 19

The financial crisis of 2008-2009 led to a decline in confidence and a credit crunch in the U.S. economy.

Accepted Answer

The financial crisis of 2008-2009 did lead to a decline in confidence and a credit crunch in the U.S. economy.

Question 20

Because of lag problems, policies intended to stabilize the economy may actually destabilize the economy.

Accepted Answer

Lag problems occur when economic policies take time to have an effect on the economy. This means that policies intended to stabilize the economy may not have an immediate impact and could actually exacerbate problems in the short term. For example, if the government implements expansionary fiscal policy (such as tax cuts or spending increases) to stimulate the economy during a recession, there may be a lag time before the policy takes effect. In the meantime, if inflationary pressures continue to build, the policy could actually make things worse in the short term. Therefore, lag problems can make it difficult to implement effective economic policies and can sometimes have unintended consequences.

Quiz 17: Issues in Macroeconomic Theory and Policy