Deck 15: A Dynamic Model of Economic Fluctuations

Question 1

The ex ante real interest rate that prevails at time t equals:

A)i_t - E_tπ_t.
B)i_t - E_tπ_{t + 1.}
C)i_t - π_t.
D)i_t - π_{t + 1.}

Answer 1

i_t - E_tπ_{t + 1.}

Question 2

Which of the following would be represented by a positive value of the random supply shock, υ_t?

A)an irrational wave of optimism among investors
B)an increase in government spending
C)widespread drought leading to large increases in food prices
D)an increase in the central bank's inflation target

Answer 2

widespread drought leading to large increases in food prices

Question 3

According to the Phillips curve, firms raise prices when output is _____ the natural level of output or, equivalently, when the unemployment rate is _____ the natural rate of unemployment.

A)above; above
B)above; below
C)below; below
D)below; above

Answer 3

above; below

Question 4

Which of the following would be represented by a negative value of the random demand shock, ε_t?

A)an irrational wave of optimism among investors
B)a decrease in government spending
C)an aggressive increase in oil prices by a cartel
D)a decrease in the central bank's inflation target

Question 5

Which of the following would be represented by a positive value of the demand shock, ε_t?

A)an irrational wave of optimism among investors
B)a decrease in government spending
C)an aggressive increase in oil prices by a cartel
D)an increase in the central bank's inflation target

Question 6

In the dynamic model, the supply shock variable, υ_t, is a variable appearing in which of the following equations of the model?

A)Fisher equation
B)Phillips curve
C)monetary-policy rule
D)adaptive expectations

Question 7

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:

A)nominal rate of interest.
B)target rate of inflation.
C)natural rate of interest.
D)current rate of inflation.

Question 8

Expectations of inflation based on recently observed inflation is called the assumption of _____ expectations.

A)natural
B)rational
C)dynamic
D)adaptive

Question 9

In the dynamic model, the demand for goods and services will _____ as the natural rate of output increases and _____ as the real interest rate increases.

A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Question 10

For any level of inflation, long-run growth _____ the demand for goods and services.

A)increases
B)decreases
C)does not change
D)may either increase or decrease

Question 11

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:

A)forecasts optimally using all available information.
B)recently observed inflation.
C)the central bank's inflation target.
D)the difference between the nominal and real interest rate.

Question 12

In the dynamic model, changes in fiscal policy are captured in changes in the:

A)natural rate of interest.
B)expected rate of inflation.
C)demand shock.
D)natural level of output.

Question 13

According to the Phillips curve, inflation depends on expected inflation because:

A)the real interest rate depends on the expected rate of inflation.
B)the central bank sets its target inflation rate based on the expected rate of inflation.
C)the natural level of output depends on the expected rate of inflation.
D)when some firms set prices in advance, expected inflation influences future prices.

Question 14

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate increases when inflation _____ its target or output _____ its natural level.

A)rises above; rises above
B)rises above; falls below
C)falls below; falls below
D)falls below; rises above

Question 15

A higher real interest rate reduces the demand for goods and services by:

A)shifting the dynamic aggregate supply curve.
B)decreasing the natural level of output.
C)increasing inflation expectations.
D)reducing investment and consumption spending.

Question 16

The nominal interest rate, i_t, is the nominal rate of return between periods:

A)t - 1 and t.
B)t and t + 1.
C)t - 1 and t + 1.
D)t and t + 2.

Question 17

The ex post real interest rate at time t equals:

A)i_t - E_tπ_t.
B)i_t - E_tπ_{t + 1.}
C)i_t - π_t.
D)i_t - π_{t + 1.}

Question 18

According to the Phillips curve, the inflation rate depends on all of the following except:

A)previously expected inflation.
B)an exogenous supply shock.
C)the real interest rate.
D)the deviation of output from its natural rate.

Question 19

According to the Fisher equation, the real interest rate equals the nominal interest rate minus the:

A)natural rate of interest.
B)expected rate of inflation.
C)expected rate of interest.
D)ex ante rate of interest.

Question 20

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural rate of output is called the _____ rate of interest.

A)ex ante
B)ex post
C)natural
D)nominal

Question 21

Long-run equilibrium occurs in the dynamic model of aggregate demand and aggregate supply when:

A)dynamic aggregate demand equals dynamic aggregate supply.
B)there are no shocks and inflation is stable.
C)the demand shock equals the supply shock.
D)the nominal interest rate equals the real interest rate.

Question 22

Of the five endogenous variables in the dynamic model of aggregate demand and aggregate supply, which two real variables do not depend on monetary policy in long-run equilibrium?

A)Y_t and π_t
B)i_t and r_t
C)E_tπ_{t + 1} and π_t
D)Y_t and r_t

Question 23

To follow a monetary policy rule, the central bank raises the nominal interest rate by:

A)raising the inflation target.
B)decreasing the money supply.
C)increasing the GDP gap.
D)decreasing inflation expectations.

Question 24

At long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, the nominal interest rate i_t equals all of the following except:

A)ρ + π_t.
B)r_t + π_t.
C)ρ + E_tπ_{t + 1.}
D)ρ + r_t.

Question 25

Of the five endogenous variables in the dynamic model of aggregate demand and aggregate supply, which are the nominal variables that will change in long-run equilibrium if the central bank changes its inflation target?

A)Y_t, r_t, and i_t
B)Y_t, i_t, and E_tπ_{t + 1}
C)π_t, i_t, and E_tπ_{t + 1}
D)r_t, π_t, and i_t

Question 26

Which of the following is an endogenous variable in the dynamic model of aggregate demand and aggregate supply?

A)π_t, inflation
B)π_t* the central bank's inflation target
C)ρ, the natural rate of interest
D)π_{t - 1}, the previous period's inflation

Question 27

The dynamic aggregate supply curve illustrates a short-run _____ relationship between output and _____.

A)positive; inflation
B)positive; the price level
C)negative; inflation
D)negative; the price level

Question 28

Which of the following is an exogenous variable in the dynamic model of aggregate demand and aggregate supply?

A)E_tπ_{t + 1}, expected inflation
B)r_t, the real interest rate
C)π_t, inflation
D)υ_t, supply shock

Question 29

The upward slope of the dynamic aggregate supply curve indicates that, holding other factors constant, high levels of economic activity are associated with:

A)the natural level of output.
B)the inflation target.
C)positive supply shocks.
D)high inflation.

Question 30

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

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

Question 31

The dynamic aggregate supply curve will shift if any of the following changes except the:

A)current inflation rate.
B)past inflation rate.
C)natural level of output.
D)supply shock.

Question 32

That output Y_t and the real interest rate r_t do not depend on the central bank's inflation target in long-run equilibrium in the dynamic model of aggregate demand and aggregate supply demonstrates:

A)monetary neutrality.
B)an impulse response function.
C)adaptive expectations.
D)Taylor's principle.

Question 33

In order to achieve the target for the nominal interest rate established by the monetary policy rule, the central bank adjusts:

A)the inflation rate.
B)the natural rate of interest.
C)the money supply.
D)the inflation target.

Question 34

The Taylor rule specifies that the Bank of Canada should increase the overnight rate as inflation _____ and the GDP gap _____.

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

Question 35

At long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, the demand and supply shocks ε_t and υ_t equal _____, and current inflation π_t equals _____.

A)0; 0
B)0; π_{t - 1}
C)π_t; 0
D)ρ

Question 36

The dynamic aggregate supply curve is derived from:

A)the Fisher equation and adaptive expectations.
B)the Phillips curve and adaptive expectations.
C)the monetary policy rule and the Fisher equation.
D)the Phillips curve and the monetary policy rule.

Question 37

The monetary policy rule specified in the dynamic model of aggregate demand and aggregate supply indicates that the central bank adjusts interest rates in response to fluctuations in:

A)inflation expectations.
B)money supply and money demand.
C)inflation and output.
D)nominal and real exchange rates.

Question 38

At long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, which variables will equal the central bank's target rate of inflation?

A)the current inflation rate, but not the expected inflation rate
B)the expected inflation rate, but not the current inflation rate
C)both the current and expected rates of inflation
D)neither the current nor the expected rates of inflation

Question 39

All of the following are endogenous variables in the dynamic model of aggregate demand and aggregate supply except:

A)Y_t, output.
B)π_t* the central bank's inflation target.
C)r_t, the real interest rate.
D)E_tπ_{t + 1}, expected inflation.

Question 40

The dynamic aggregate supply curve shows the short-run relation between:

A)the natural rate of output and inflation.
B)the natural rate of output and expected rate of inflation.
C)output and inflation.
D)output and the natural rate of interest.

Question 41

The dynamic aggregate demand curve illustrates the _____ relationship between the quantity of output in the short run and _____.

A)positive; inflation
B)positive; the price level
C)negative; inflation
D)negative; the price level

Question 42

When the central bank lowers its target inflation rate, it _____ the nominal and real interest rate, which shifts the dynamic aggregate demand curve to the _____.

A)lowers; right
B)lowers; left
C)raises; right
D)raises; left

Question 43

In the dynamic model of aggregate demand and aggregate supply, one period in time is connected to the next period through:

A)the monetary policy rule.
B)demand shocks.
C)inflation expectation.
D)the natural level of output.

Question 44

The short-run equilibrium in the dynamic model of aggregate demand and supply determines the:

A)inflation rate and inflation target.
B)real interest rate and natural level of output.
C)level of output and inflation rate.
D)natural level of output and level of output.

Question 45

The short-run equilibrium in the dynamic model of aggregate demand and aggregate supply is determined by the intersection of the:

A)DAD_t and DAS_{t - 1}.
B)DAD_t and DAS_t.
C)Y_t and DAS_t.
D)DAD_{t - 1} and Y_t.

Question 46

The dynamic aggregate demand curve will shift to the right if there is a:

A)tax cut.
B)cut in government spending.
C)decrease in the money supply.
D)cut in oil prices when the cartel falls apart.

Question 47

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the first period of a four-period positive demand shock, the DAS curve _____, and the DAD curve _____.

A)shifts upward; shifts rightward
B)does not shift; shifts rightward
C)does not shift; does not shift
D)shifts downward; shifts leftward

Question 48

Graphs that illustrate the time paths of endogenous variables when a shock hits the economy are called:

A)monetary policy paths.
B)dynamic shock figures.
C)impulse response functions.
D)endogenous growth models.

Question 49

Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, output immediately decreases as a result of a one-period positive supply shock because:

A)the central bank raises the nominal and real interest rates in response to the increase in inflation.
B)the higher prices generate a negative demand shock that reduces output.
C)the natural level of output falls in response to the increase in inflation.
D)the central bank increases the target rate of inflation in response to the increase in inflation.

Question 50

In the dynamic model of aggregate demand and aggregate supply, changes in the natural level of output change:

A)the DAD curve, but not the DAS curve.
B)the DAS curve. but not the DAD curve.
C)both the DAD curve and the DAS curve.
D)neither the DAD nor the DAS curve.

Question 51

The dynamic aggregate demand curve is derived from each of the following equations of the model of aggregate demand and aggregate supply except:

A)the Fisher equation.
B)the Phillips curve.
C)adaptive expectations.
D)the monetary policy rule.

Question 52

The dynamic aggregate demand curve will shift if any of the following changes except the:

A)current inflation rate.
B)inflation target.
C)natural level of output.
D)demand shock.

Question 53

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the period in which a positive supply shock occurs, the DAS curve _____, and the DAD curve _____.

A)shifts upward; shifts rightward
B)shifts upward; does not shift
C)does not shift; does not shift
D)shifts downward; shifts leftward

Question 54

Which of the following is not held constant along a dynamic aggregate demand curve?

A)the inflation target
B)the natural rate of output
C)the demand shock
D)the money supply

Question 55

Increases in the natural level of output allow the economy to produce _____ goods and services and make people want to buy _____ goods and services.

A)fewer; fewer
B)fewer; more
C)more; more
D)more; fewer

Question 56

Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, a one-period positive supply shock causes output to:

A)remain above the natural level for only one period.
B)remain above the natural level for more than one period.
C)remain below the natural level for only one period.
D)remain below the natural level for more than one period.

Question 57

In the dynamic model of aggregate demand and aggregate supply, increases in the natural level of output lead to _____ in output and _____ in inflation.

A)increases; increases
B)increases; no change
C)no change; increases
D)no change; no change

Question 58

To reduce the demand for goods and services, the central bank will _____ its target inflation rate and _____ nominal and real interest rates.

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

Question 59

The dynamic aggregate demand curve is downward sloping because as inflation falls, the central bank reduces the nominal interest rate by more than the fall in the inflation rate, which _____ the real interest rate and _____ the quantity of goods and services demanded.

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

Question 60

According to the monetary policy rule (assuming θ_π > 0) when inflation increases, the central bank increases the nominal interest rate by _____ the increase in the rate of inflation, which _____ the real interest rate.

A)more than; increases
B)less than; decreases
C)an amount equal to; does not change
D)less than; increases

Question 61

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the periods after a multiperiod positive demand shock occurs, the DAS shifts upward because:

A)the central bank increases the target rate of inflation in response to higher rates of inflation.
B)the deviation of output from the natural level of output increases as result of higher rates of inflation.
C)higher rates of inflation generate positive supply shocks.
D)expectations of inflation increase as a result of higher inflation in previous periods.

Question 62

A central bank that chooses a small value of θ_π and a large value of θ_Y is choosing less _____ at the expense of more _____.

A)inflation; output
B)output; inflation
C)inflation variability; output variability
D)output variability; inflation variability

Question 63

Use the model of dynamic aggregate demand and aggregate supply to graphically illustrate the impact on output and inflation of an exceptional weather pattern that results in a one-period glut of food worldwide that reduces food prices (a one-period negative supply shock) when the economy is initially at long-run equilibrium. Explain the time path of output and inflation in words.

Question 64

Fill in the blanks: As a dynamic response to a positive supply shock in the short run, the DAS curve shifts (say in period t) _____ while the DAD curve _____, causing inflation to _____ and output to _____.

Question 65

How does the AD-AS model take a novel approach to explaining money supply effects on economic fluctuations?

Question 66

What is the difference between the ex ante real interest rate and the real interest rate? Explain the Fisher equation used by the AD-AS model in light of this difference.

Question 67

Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, a permanent reduction in the central bank's inflation target causes the nominal interest rate to:

A)decline continuously until reaching a lower level in the long run.
B)increase initially and then decline until reaching a lower level in the long run.
C)decline immediately to a lower level in the long run.
D)fall below and then rise continuously to long-run level below the initial level.

Question 68

Illustrate with graphs the dynamic aggregate demand curve (DAD) and dynamic aggregate supply curve (DAS).

Question 69

A central bank that chooses a large value of θ_π and a small value of θ_Y is choosing to obtain less _____ at the expense of more _____.

A)inflation; output
B)output; inflation
C)inflation variability; output variability
D)output variability; inflation variability

Question 70

Use the model of dynamic aggregate demand and aggregate supply to graphically illustrate the impact of a permanent increase in the central bank's inflation target when the economy is initially at long-run equilibrium. Explain the time path of output and inflation in words.

Question 71

Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, a five-period positive demand shock causes output to _____ until returning to the natural level in the long run.

A)remain continuously above the natural level of output
B)move above and then below the natural level of output
C)remain continuously below the natural level of output
D)move below and then above the natural level of output

Question 72

According to the Taylor principle, for inflation to be stable, the central bank must respond to an increase in inflation with _____ increase in the nominal interest rate.

A)no
B)an equal
C)a greater
D)a smaller

Question 73

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, if the central bank permanently reduces its inflation target, then in the initial period after the policy change, output _____, and inflation _____.

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

Question 74

In the dynamic model of aggregate demand and aggregate supply, if the central bank chooses a large value of θ_π and a small value of θ_Y, then the DAD curve will be relatively _____, and supply shocks will have relatively _____ impacts on inflation than output.

A)flat; larger
B)flat; smaller
C)steep; larger
D)steep; smaller

Question 75

Use the model of dynamic aggregate demand and aggregate supply to graphically illustrate the impact of a temporary four-period increase in taxes (a four-period negative demand shock) on output and inflation when the economy is initially at long-run equilibrium. Explain the time path of output and inflation in words.

Question 76

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the first period of a multi-period positive demand shock, output _____, and inflation _____.

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

Question 77

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, in the periods after a permanent reduction in the central bank's inflation target, the DAS shifts downward because:

A)the natural level of output increases in response to the lower rates of inflation.
B)the deviation of output from the natural level of output increases as a result of lower rates of inflation.
C)lower rates of inflation generate negative supply shocks.
D)expectations of inflation decrease as a result of lower inflation in previous periods.

Question 78

Starting from long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, a temporary five-period tax increase causes output to _____ returning to the natural level in the long run.

A)remain continuously above the natural level of output until
B)move above and then below the natural level of output until
C)remain continuously below the natural level of output until
D)move below and then above the natural level of output before

Question 79

Use the model of dynamic aggregate demand and aggregate supply to compare the time paths of output and inflation in response to a one-period positive demand shock versus a one-period positive supply shock.

Question 80

Beginning at long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, if the central bank permanently reduces its inflation target, then in the first period after the policy change, the DAS curve _____, and the DAD curve _____.

A)shifts upward; shifts rightward
B)does not shift; shifts leftward
C)does not shift; does not shift
D)shifts downward; shifts leftward