Question 1

A credit crunch will&#10;A) Raise borrowing costs to businesses and households relative to benchmark interest rates&#10;B) Tend to reduce aggregate demand&#10;C) Cause a negative output gap (if output had been at potential)&#10;D) All of the above

Accepted Answer

A credit crunch raises borrowing costs, reduces aggregate demand, and can cause a negative output gap if output was at potential.

Question 2

A main reason why the Fed introduced large-scale asset purchases (quantitative easing) to deal with the Great Recession was&#10;A) It had already lowered its policy rate to zero and could go no lower&#10;B) It was in an experimental mood&#10;C) It sought to relieve pressure on the federal budget&#10;D) This was a coordinated action with foreign central banks

Accepted Answer

The Fed introduced large-scale asset purchases, also known as quantitative easing, primarily because it had already lowered its policy rate to near zero and could not reduce it further to stimulate the economy. This unconventional monetary policy tool was used to provide additional stimulus.

Question 3

A positive aggregate demand shock affecting an economy that had been operating at potential output&#10;A) Would require a tighter monetary policy if the shock were persistent&#10;B) Would require a tighter policy if the shock were one-off and inflation expectations ratcheted upward&#10;C) Would require no action by the central bank&#10;D) Both a and b

Accepted Answer

A positive aggregate demand shock in an economy operating at potential output can lead to inflationary pressures. If the shock is persistent, tighter monetary policy can help mitigate these pressures (A). Similarly, if the shock is one-off but leads to higher inflation expectations (B), a tighter policy may also be necessary to anchor those expectations and prevent an inflationary spiral.

Question 4

A negative aggregate supply shock will&#10;A) Cause output to fall and inflation to fall&#10;B) Cause output to fall and inflation to increase&#10;C) Not affect output, but cause inflation to increase&#10;D) Not affect output or inflation

Accepted Answer

A negative aggregate supply shock, such as a sudden increase in oil prices, typically causes output to fall due to higher production costs and inflation to increase as the higher costs are passed on to consumers in the form of higher prices.

Question 5

A persistent positive aggregate supply shock, say a productivity shock, will&#10;A) Cause output to rise more rapidly and inflation to fall&#10;B) Cause output and inflation to rise more rapidly&#10;C) Cause output to rise more rapidly and inflation to be unaffected&#10;D) Cause inflation to rise more rapidly but output to be unaffected

Accepted Answer

A persistent positive aggregate supply shock, such as a productivity shock, increases the economy's capacity to produce goods and services. This leads to higher output as the economy can produce more efficiently. At the same time, the increased supply of goods and services tends to lower prices, or at least reduce the pressure on prices to rise, leading to lower inflation.

Question 6

The economy can move and stay off path for a time because&#10;A) Shocks to aggregate demand&#10;B) Lags in information&#10;C) Lags in the effects of policy actions&#10;D) All of the above

Accepted Answer

All of the options listed are reasons why the economy can deviate from its expected path for a period. Shocks to aggregate demand, lags in information, and lags in the effects of policy actions can all contribute to the economy moving and staying off its anticipated trajectory temporarily.

Question 7

When news about the economy points to weakness, actions taken by market participants anticipating policy actions by the central bank&#10;A) Will help to stabilize the economy if the participants assess this information correctly&#10;B) Will tend to push the economy off course if the participants assess the information incorrectly&#10;C) Will be irrelevant to economic outcomes&#10;D) Both a and b

Accepted Answer

When news about the economy indicates weakness, market participants often anticipate policy actions by the central bank. If their assessments are correct, their actions can help stabilize the economy. Conversely, if their assessments are incorrect, their actions can push the economy off course. Therefore, both statements A and B are correct, making D the correct choice.

Question 8

Central bank credibility&#10;A) Is irrelevant to the effectiveness of monetary policy&#10;B) Is strengthened by a lack of central bank independence&#10;C) Is strengthened by central bank independence&#10;D) None of the above

Accepted Answer

Central bank independence is crucial for maintaining credibility in the eyes of the public and the markets. When a central bank operates independently of political pressures, it can make decisions based on economic indicators and long-term goals, such as controlling inflation and ensuring financial stability. This independence helps in building trust that the central bank will act in the economy's best interest, rather than in response to short-term political considerations.

Question 9

Having a single monetary policy goal of price stability or low inflation&#10;A) Implies that output and employment will routinely suffer&#10;B) Implies that inflation will be more volatile&#10;C) Implies that inflation and output and employment can be more stable if the single goal causes inflation expectations to be better anchored&#10;D) None of the above

Accepted Answer

A single monetary policy goal of price stability or low inflation can lead to more stable inflation and output and employment if it results in better-anchored inflation expectations. When people and businesses expect low and stable inflation, they make decisions that contribute to economic stability, reducing the volatility of both inflation and the real economy.

Question 10

If output were at potential and inflation were 4 percent (2 percent above the central bank's target), the appropriate setting of the federal funds rate under a Taylor would be&#10;A) 4 percent&#10;B) 7 percent&#10;C) 6 percent&#10;D) Cannot be determined from the information given

Accepted Answer

The Taylor Rule formula suggests that the federal funds rate should be adjusted based on the current inflation rate and the deviation of actual economic output from potential output. Given that inflation is 2 percent above the target, and assuming the central bank's target inflation rate is 2 percent (as implied), the Taylor Rule would suggest setting the federal funds rate at 1% (the assumed neutral rate) + 2% (the target inflation rate) + 0.5*2% (the deviation from target inflation) + 0.5*0 (since output is at potential, there's no output gap), totaling 4% + 0.5*2% = 5% + 2% (for the inflation rate being 2 percent above target) = 7%.

Question 11

Advocates of a money stock rule have argued that&#10;A) Such a rule would help to control inflation&#10;B) Such a rule would help to stabilize output and employment&#10;C) Such a rule requires stability of money demand&#10;D) All of the above

Accepted Answer

The answer of Advocates of a money stock rule have...

Question 12

Because of the financial crisis&#10;A) Aggregate demand plunged&#10;B) The level of the federal funds rate required to restore output to potential and to stabilize inflation was negative&#10;C) The Fed augmented a federal funds rate of zero with forward guidance and large-scale asset purchases&#10;D) All of the above

Accepted Answer

The answer of Because of the financial crisis&#10;A) Aggregate demand...

Deck 14: Monetary Policy: Challenges Faced by Policymakers