Deck 13: Stabilization Policy

Question 1

The outside lag is the time:

A)before automatic stabilizers respond to economic activity.
B)when automatic stabilizers are not effective.
C)between a shock to the economy and the policy action responding to the shock.
D)between a policy action and its influence on the economy.

Answer 1

between a policy action and its influence on the economy.

Question 2

The concerns of economists who favor passive over active policy are most closely associated with their:

A)preference for using monetary policy rather than fiscal policy for stabilization.
B)view that policy made by rules is superior to policy made by discretion.
C)belief that shocks to modern economies are not large enough to require any policy response.
D)doubt that the correct policy will be implemented at the correct time.

Answer 2

doubt that the correct policy will be implemented at the correct time.

Question 3

The time between a shock to the economy and the policy action responding to that shock is called the:

A)automatic stabilizer.
B)time inconsistency of policy.
C)inside lag.
D)outside lag.

Answer 3

inside lag.

Question 4

The lags involved in implementing monetary and fiscal policy are:

A)short and predictable.
B)long and predictable.
C)short and variable.
D)long and variable.

Question 5

The time between when a recession begins and when the central bank lowers interest rates to stimulate aggregate demand is an example of an:

A)inside lag of monetary policy.
B)outside lag of monetary policy.
C)inside lag of fiscal policy.
D)outside lag of fiscal policy.

Question 6

Increasing government spending when the economy is in a recession is an example of:

A)active monetary policy.
B)active fiscal policy.
C)passive monetary policy.
D)passive fiscal policy.

Question 7

Economists who view the economy as inherently unstable generally argue that:

A)stabilization policy is too dangerous to be used.
B)the economy should be stimulated when it is depressed and slowed when it is overheated.
C)the economy should be slowed when it is depressed and stimulated when it is overheated.
D)monetary and fiscal policies should follow rigid rules of constant growth.

Question 8

The lag between the time that the money supply is increased and the time that investment expenditures increase is an example of a:

A)fiscal inside lag. fiscal
B)outside lag. monetary
C)inside lag. monetary
D)outside lag.

Question 9

The lawmakers who wrote the Employment Act of 1946 believed that:

A)the economy was naturally stable.
B)the Great Depression could not happen again.
C)without active government policy the Great Depression could occur again.
D)monetary policy should be conducted according to rules.

Question 10

Economists who view the economy as naturally stable often argue that:

A)monetary and fiscal policies should not be used to "fine-tune" the economy.
B)the economy should be stimulated when it is depressed and slowed when it is overheated.
C)the economy should be slowed when it is depressed and stimulated when it is overheated.
D)economists should act to stimulate or slow the economy on the basis of forecasts in order to assure that the policy actions are timely.

Question 11

Keeping the money supply constant over the business cycle is an example of:

A)active monetary policy.
B)active fiscal policy.
C)passive monetary policy.
D)passive fiscal policy.

Question 12

Fiscal policy has a relatively long lag, and monetary policy has a relatively long lag.

A)inside; outside
B)outside; inside
C)inside; inside
D)outside; outside

Question 13

Active economic policy seeks to do all of the following except:

A)offset fluctuations in real GDP.
B)use monetary and fiscal policy to shift aggregate demand.
C)respond to changing economic conditions.
D)take a hands-off approach to macroeconomic policy.

Question 14

The time between a policy action and its influence on the economy is called the:

A)automatic stabilizer.
B)time inconsistency of policy.
C)inside lag.
D)outside lag.

Question 15

All of the following U.S. federal agencies are directly concerned with macroeconomic policy except the:

A)Council of Economic Advisers.
B)Congressional Budget Office.
C)Federal Reserve.
D)Department of Health and Human Services.

Question 16

Arguments in favor of passive economic policy include all of the following except:

A)monetary and fiscal policies work with long and variable lags, which can produce destabilizing results.
B)economic forecasts have too large a margin of error to be useful in formulating stabilization policy.
C)recessions do not reduce economic well-being, so using monetary and fiscal policy for stabilization is unnecessary.
D)the Great Depression could have been avoided if the Federal Reserve had pursued a policy of steady money growth.

Question 17

The inside lag is the time:

A)before automatic stabilizers respond to economic activity.
B)after automatic stabilizers respond to economic activity.
C)between a shock to the economy and the policy action responding to the shock.
D)between a policy action and its influence on the economy.

Question 18

Passive economic policy seeks to:

A)offset fluctuations in real GDP.
B)use monetary and fiscal policy to shift aggregate demand.
C)respond to changing economic conditions.
D)take a hands-off approach to macroeconomic policy.

Question 19

Arguments in favor of active economic policy include all of the following except:

A)failing to use monetary and fiscal policy leads to inefficient fluctuations in output and employment.
B)the Great Depression could have been avoided if the Federal Reserve had pursued a policy of steady money growth.
C)fluctuations in real GDP have been less severe following World War II than prior to World War I.
D)failure of policymakers to respond to large contractionary shocks to private spending caused the Great Depression.

Question 20

The lag between the time that economic stimulus is needed and the time that a tax cut is passed by Congress is an example of a:

A)fiscal inside lag. fiscal
B)outside lag. monetary
C)inside lag. monetary
D)outside lag.

Question 21

Advocates of passive policy argue that because monetary and fiscal policy lags are:

A)short and fixed these policies should not be used to offset shocks.
B)long and variable these policies should not be used to offset shocks.
C)short and fixed these policies should be used to offset shocks.
D)long and variable these policies should be used to offset shocks.

Question 22

If past policies kept the economy insulated from shocks to aggregate demand and supply, the historical evidence would support using:

A)active macroeconomic policy only.
B)passive macroeconomic policy only.
C)either active or passive macroeconomic policy.
D)neither active nor passive macroeconomic policy.

Question 23

The time between when government spending increases and when aggregate demand starts to increase is an example of an:

A)inside lag of monetary policy.
B)outside lag of monetary policy.
C)inside lag of fiscal policy.
D)outside lag of fiscal policy.

Question 24

According to advocates of rational expectations, traditional estimates of the sacrifice ratio are unreliable because they:

A)ignore inside lags.
B)overestimate outside lags.
C)are based on adaptive expectations.
D)are time inconsistent.

Question 25

Which of the following is an example of a fiscal policy that has no inside lag?

A)a decrease in income tax rates
B)an ongoing unemployment insurance program
C)an increase in government spending for job training
D)a reduction in the age at which people become eligible for retirement benefits

Question 26

If past economic fluctuations resulted from inept economic policies, then the historical evidence would support using:

A)active macroeconomic policy only.
B)passive macroeconomic policy only.
C)either active or passive macroeconomic policy.
D)neither active nor passive macroeconomic policy.

Question 27

The differing interpretations of the historical record of the Great Depression provide support for using:

A)active macroeconomic policy only.
B)passive macroeconomic policy only.
C)either active or passive macroeconomic policy.
D)neither active nor passive macroeconomic policy.

Question 28

The fact that traditional methods of policy evaluation do not take into account the impact of policy on expectations is known as:

A)stabilization policy.
B)the political business cycle.
C)the Lucas critique.
D)Okun's law.

Question 29

All of the following could be considered automatic stabilizers except:

A)a profit-sharing system for workers.
B)discretionary changes in taxes.
C)a system of unemployment insurance.
D)the federal income tax.

Question 30

Because monetary and fiscal lags are long and variable:

A)stronger policies must be used.
B)successful stabilization policy is completely impossible.
C)attempts to stabilize the economy are often destabilizing.
D)policy must be completely passive.

Question 31

According to Christina Romer, the reduction in real economic volatility in the period since World War II compared to the period before World War I is the result of improved economic:

A)policy.
B)performance.
C)data.
D)forecasting.

Question 32

The long and variable lag before a policy influences the economy makes the job of economic forecasters:

A)impossible.
B)easier.
C)less important.
D)more important.

Question 33

Economic forecasters did:

A)well in forecasting the Great Depression but did poorly in forecasting the recession of 1982.
B)poorly in forecasting both the Great Depression and the recession of 1982.
C)well in forecasting both the Great Depression and the recession of 1982.
D)poorly in forecasting the Great Depression but did well in forecasting the recession of 1982.

Question 34

What are two types of tools that economists use to forecast future economic developments?

A)leading indicators and computer models
B)direct imputations and indirect attributions
C)visual assessment and global positioning
D)monetary instruments and fiscal instruments

Question 35

According to the Lucas critique, when economists evaluate alternative policies they must take into consideration:

A)how the policies will affect expectations and behavior.
B)whether the policy will offset the impact of automatic stabilizers.
C)the stage of the political business cycle in which the policy is to be implemented.
D)the length of the inside lags associated with the policies.

Question 36

The Lucas critique argues that because the way people form expectations is based on government policies, economists predict the effect of a change in policy without taking changing expectations into account.

A)partly; cannot
B)only partly; can
C)in no way; can
D)in no way; cannot

Question 37

Automatic stabilizers:

A)require congressional action before each time that they are put into effect.
B)have no outside lag.
C)have no inside lag.
D)have long and variable inside lags.

Question 38

Policies that stimulate or depress the economy without any deliberate policy change are called:

A)leading indicators.
B)time inconsistent policies.
C)rational expectations policies.
D)automatic stabilizers.

Question 39

If people's expectations of inflation are formed rationally rather than based on adaptive expectations and if policymakers make a credible policy move to reduce inflation, then the costs of reducing inflation will be traditional estimates of the sacrifice ratio.

A)much higher than
B)much lower than
C)exactly equal to
D)approximately two percent greater than

Question 40

Computer models of the economy:

A)usually consist of only a few equations.
B)require no assumptions about monetary and fiscal policy.
C)require assumptions about monetary and fiscal policy.
D)give excellent predictions regardless of assumptions about monetary and fiscal policy.

Question 41

The political business cycle refers to the:

A)pattern of holding primaries, conventions, and general elections every four years.
B)cycle of electing U.S. representatives every two years, the U.S. president every four years, and U.S. senators every six years.
C)manipulation of the economy to win elections.
D)pattern of recession and expansion that follows every election.

Question 42

Policymakers may be better able to achieve their goals using a fixed policy rule rather than using discretion if they face the problem of:

A)short and predictable inside lags.
B)time-inconsistent policy.
C)short and predictable outside lags.
D)weak automatic stabilizers.

Question 43

Policy is conducted by rule if policymakers:

A)announce in advance how policy will respond to various situations and commit themselves to following through on this announcement.
B)are free to size up the situation case by case and choose whatever policy seems appropriate at the time.
C)set policy according to election results, i.e., set policy by rule of the ballot box.
D)manipulate policy to ensure both low inflation and unemployment on election day.

Question 44

A time-inconsistency problem in macroeconomic policy can occur when the policymaker:

A)is made to follow a strict and an inflexible rule.
B)has discretion in the short run but follows a rule in the long run.
C)has discretion to act as it seems best in each situation, based on his or her own knowledge and experience.
D)has no discretion.

Question 45

A situation where policymakers have the incentive to deviate from their initial course of action once other agents in the economy have acted is called a(n):

A)rational expectation.
B)outside lag.
C)time inconsistent policy.
D)active policy rule.

Question 46

If the Fed has discretion to choose its own policy and announces a policy of low inflation, then:

A)the policymaker is required to make the money supply grow at a low rate.
B)private economic agents are sure to believe the announcement because it is credible.
C)private economic actors are likely to discount the policy because the Fed has an incentive to renege on its policy once expectations are formed.
D)the Fed is certain to renege on its policy once expectations are formed because then it can lower unemployment with minimum inflation.

Question 47

Assume that there is a short-run tradeoff between inflation and unemployment, that the central bank desires both low inflation and low unemployment, and that the central bank follows a fixed rule in conducting monetary policy. Initially, households and firms expect high inflation. Following a credible announcement by the central bank of a low-inflation policy, households and firms will the central bank's announcement and their expectations of inflation.

A)believe; lower
B)not believe; not change
C)believe; not change
D)not believe; lower

Question 48

Policy is conducted by discretion if policymakers:

A)announce in advance how policy will respond to various situations and commit themselves to following through on this announcement.
B)are free to size up the situation case by case and choose whatever policy seems appropriate at the time.
C)announce and maintain a constant growth rate of the money supply.
D)announce and achieve a balanced government budget.

Question 49

Assume that there is a short-run tradeoff between inflation and unemployment, that the central bank desires both low inflation and low unemployment, and that the central bank uses discretion in conducting monetary policy. Initially, households and firms expect high inflation. Following an announcement by the central bank of a low-inflation policy, households and firms will the central bank's announcement and their expectations of inflation.

A)believe; lower
B)not believe; not change
C)believe; not change
D)not believe; lower

Question 50

Conducting fiscal policy so that G = T + β (u - u ), where G is government expenditures, T is n
Tax revenue, u is the unemployment rate, u
N
Is the natural rate of unemployment, and β is a
Positive number, is an example of a(n):

A)active rule. passive
B)rule. discretionary
C)policy. automatic
D)stabilizer.

Question 51

When a government honors its debt obligations, this is an example of:

A)discretionary fiscal policy.
B)discretionary monetary policy.
C)a fiscal policy rule.
D)a monetary policy rule.

Question 52

A policy rule:

A)must specify money growth at a constant rate.
B)must specify an active policy.
C)must specify a passive policy.
D)may specify either an active or a passive policy.

Question 53

If policymakers are free to analyze events as they occur and choose whatever policy seems appropriate at the time, then this is:

A)policy by rule.
B)policy by discretion.
C)monetary policy.
D)fiscal policy.

Question 54

If citizens vote on the basis of both low inflation and low unemployment at the time of the election, then presidents might, in order to ensure their reelection:

A)spur inflation soon after their elections, and then cause a recession.
B)stimulate the economy throughout their terms.
C)cause a recession soon after their elections, and then stimulate the economy.
D)run a tight monetary and fiscal policy throughout their terms.

Question 55

If policymakers announce in advance how policy will respond to various situations and commit themselves to following through on this announcement, this is:

A)policy by rule.
B)policy by discretion.
C)time inconsistent policy.
D)monetary policy.

Question 56

Conducting fiscal policy so that G = T, where G is government expenditures and T is tax revenue, is an example of a(n):

A)active rule. passive
B)rule. discretionary
C)policy. automatic
D)stabilizer.

Question 57

As Secretary of the Treasury, Alexander Hamilton opposed the time-inconsistent policy of:

A)repaying the debt.
B)raising taxes.
C)repudiating the debt.
D)reducing taxes.

Question 58

Conducting monetary policy so that FF rate = inflation+ 0.5 (inflation - 2) + 0.5 (GDP gap), where FF rate is the nominal federal funds interest rate and GDP gap if the percentage shortfall of real GDP from its natural level, is an example of:

A)an active policy rule.
B)a passive policy rule.
C)discretionary policy.
D)an automatic stabilizer.

Question 59

The manipulation of the economy to win elections is called:

A)discretionary monetary policy.
B)discretionary fiscal policy.
C)the political business cycle.
D)an automatic stabilizer.

Question 60

Conducting monetary policy so that FF rate = .05 where FF rate is the nominal federal funds interest rate, is an example of :

A)an active policy rule.
B)a passive policy rule.
C)discretionary policy.
D)an automatic stabilizer.

Question 61

The Taylor rule can be written as FF rate = inflation + 2.0 + 0.5 (inflation - 2.0) + 0.5 (GDP gap), where FF rate is the nominal federal funds rate and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and the GDP gap is -2 percent, then according to the Taylor rule, the Fed should set the nominal federal funds rate at percent.

A)2
B)3
C)4
D)5

Question 62

If the velocity of money varies a great deal, steady growth of the money supply is a(n):

A)ineffective way to stabilize aggregate demand.
B)example of discretionary monetary policy.
C)automatic stabilizer.
D)active policy rule.

Question 63

The interest rate at which banks make loans to other banks is called the:

A)federal funds rate.
B)prime rate.
C)Federal Reserve discount rate.
D)Treasury bill rate.

Question 64

In practice, inflation targeting is better considered operating with constrained discretion rather than according to a policy rule because central banks with inflation targets typically:

A)are not allowed to adjust the target in the event of shocks.
B)set the inflation target as a range rather than as a particular number.
C)are not held accountable for achieving their target.
D)must achieve their target regardless of economic conditions.

Question 65

Research indicates that greater central-bank independence is correlated with:

A)higher average growth rates of real GDP.
B)lower rates of unemployment.
C)lower and more stable rates of inflation.
D)less volatility of real GDP.

Question 66

Although real variables such as unemployment and real GDP are the best measures of economic performance, most economists do not advocate manipulating money supply directly to hit a real target because:

A)they believe a constant growth rate of the money supply is the best way to stabilize real GDP or unemployment.
B)if the Fed chose a target that was not natural output or the natural unemployment rate, the result would be accelerating inflation or deflation.
C)if the Fed chose a target for the unemployment rate above the natural rate, the result would be accelerating inflation.
D)if the Fed chose a target for the unemployment rate below the natural rate, the result would be accelerating deflation.

Question 67

The Taylor rule can be written as FF rate = inflation + 2.0 + 0.5 (inflation - 2.0) + 0.5 (GDP gap), where FF rate is the nominal federal funds rate and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and GDP is at the natural rate, then according to the Taylor rule, the Fed should set the nominal federal funds rate at percent.

A)2
B)3
C)4
D)5

Question 68

Unlike a monetarist policy rule, an inflation target has the advantage of:

A)eliminating the need to announce the policy target.
B)providing a real target rather than a nominal one.
C)allowing the central bank unlimited discretion.
D)insulating the economy from changes in money velocity.

Question 69

Inflation targeting is a monetary policy rule that requires the central bank to adjust in order to attain the desired inflation rate.

A)a price index
B)the velocity of money
C)nominal GDP
D)the money supply

Question 70

Monetary policy rules that target nominal variables would target any of the following except the:

A)price level. money
B)supply unemployment
C)rate. level of nominal
D)GDP.

Question 71

Economic science has provided convincing evidence in favor of the:

A)rule favoring a constant rate of growth of the money supply.
B)rule favoring use of the money supply to hit a nominal GDP target.
C)rule requiring a constantly balanced budget for the federal government.
D)fact that there is no simple and compelling case for any particular view of macroeconomic policy.

Question 72

According to the Taylor rule, when real GDP is above its natural level, the nominal federal funds rate should be , and when inflation is below 2 percent, the nominal Federal funds rate should be .

A)raised; raised
B)raised; lowered
C)lowered; raised
D)lowered; lowered

Question 73

Monetarists believe all of the following except:

A)fluctuations in the money supply are responsible for most large fluctuations in the economy.
B)the Fed should keep the money supply growing at a steady rate.
C)slow and steady growth of the money supply would yield stable output, employment, and prices.
D)the Fed should adjust the money supply to adjust to various shocks to the economy.

Question 74

Countries with greater central-bank independence can achieve lower rates of inflation:

A)at the cost of higher levels of unemployment.
B)at the cost of slower growth rates of real GDP.
C)at the cost of greater volatility of real GDP.
D)with no apparent real economic costs.

Question 75

Assume that the Democrats always had a policy of high money growth whereas the Republicans followed a policy of low money growth, and the economy had a standard Phillips curve. Then, if the two parties took regular terms in office:

A)there would be no political business cycle, but inflation would be higher under the Democrats.
B)there would be no political business cycle, but inflation would be higher under the Republicans.
C)unemployment would be lower under the Democrats but inflation would be higher.
D)both unemployment and inflation would be higher under the Democrats.

Question 76

The Taylor rule can be written as FF rate = inflation + 2.0 + 0.5 (inflation - 2.0) + 0.5 (GDP gap), where FF rate is the nominal federal funds rate and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 4 percent and the GDP gap is 2 percent, then according to the Taylor rule, the Fed should set the nominal federal funds rate at percent.

A)4
B)8
C)10
D)12

Question 77

John Taylor's rule for setting the federal funds rate proposes increasing the nominal federal funds rate as inflation and the GDP gap .

A)increases; increases
B)increases; decreases
C)decreases; increases
D)decreases; decreases

Question 78

If a city passes laws limiting rents on apartments, but promises to exempt buildings not yet built:

A)construction of new buildings will not be discouraged.
B)construction of new buildings may be discouraged.
C)builders will not expect the city to renege on its promise.
D)the city will have no incentive to renege on its promise.

Question 79

A monetary policy rule that targets nominal GDP would money growth when nominal GDP rises above the target and money growth when nominal GDP falls below the target.

A)reduce; raise
B)raise; reduce
C)reduce; reduce
D)raise; raise

Question 80

According to the Taylor rule, when real GDP is below its natural level, the nominal federal funds rate should be , and when inflation exceeds 2 percent, the nominal federal funds rate should be .

A)raised; raised
B)raised; lowered
C)lowered; raised
D)lowered; lowered