Deck 35: The Short-Run Trade-Off Between Inflation and Unemployment

Question 1

Proponents of rational expectations theory argue that when government policies change, people adjust their expectations accordingly, and that failure to include that fact once led to estimates of the sacrifice ratio that were unreliable guides to policy.

Answer 1

True

Question 2

If the sacrifice ratio is five, it means that for each percentage point that inflation is reduce, one per cent of annual output must be sacrificed in the transition.

Answer 2

False

Question 3

Phillips said that a central bank cannot use its control over nominal quantities to peg a real quantity - the real rate of interest, the rate of unemployment, the level of real national income, the real quantity of money, the rate of growth of real national income, or the rate of growth of the real quantity of money.

Answer 3

False

Question 4

Contractionary monetary policy contracts aggregate demand, reduces employment and inflation, and eventually reduces expected inflation, causing the short-run Phillips curve to shift downwards.

Question 5

If decreases in money supply or cuts in government contract aggregate demand, they can lower inflation in the short run, but only at the expense of higher unemployment.

Question 6

The Phillips curve implies that the economy faces a:

A)long-run trade-off between price inflation and the level of real wages
B)long-run trade-off between inflation and unemployment
C)short-run trade-off between the actual unemployment rate and the natural rate of unemployment
D)short-run trade-off between inflation and unemployment

Question 7

NAIRU (non-accelerating inflation rate of unemployment) refers to the level of unemployment that does not result in increases in the inflation rate.

Question 8

According to the textbook, the sacrifice ratio should be ignored when attempting to reduce inflation beyond acceptable targets as continued inflation has dire consequences.

Question 9

When the money supply changes, the aggregate-demand curve shifts and the economy moves along a given short-run aggregate-supply curve, causing unexpected changes in output, prices, unemployment and inflation.These changes cause people to adjust their expectations of inflation, leading to shifts in the short-run aggregate-supply curve.

Question 10

The Phillips curve simply shows the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate- demand curve move the economy along the short-run aggregate-supply curve.

Question 11

Rational expectations theory is based on the assumption that people optimally allocate their incomes - that is, they decide how much they consume and how much they save.

Question 12

Okun's law tells us that greater output means a lower rate of unemployment.Thus, an increase in aggregate demand moves the economy along the Phillips curve to a point with lower unemployment and higher inflation.

Question 13

A typical estimate of the sacrifice ratio is five.According to Sargent, the sacrifice ratio could be much smaller than suggested by previous estimates.

Question 14

Samuelson and Solow reasoned that the trade-off between inflation and unemployment arose because low unemployment was associated with high aggregate demand, and because high demand puts upward pressure on wages and prices throughout the economy.

Question 15

The natural rate hypothesis states that if policymakers choose higher inflation in order to reduce unemployment below the natural rate, they will succeed at reducing unemployment permanently.

Question 16

According to rational expectations theory, a credible commitment to low inflation increases the cost of disinflation, because people are rational.

Question 17

Phillips's discovery in the UK was supported by a similar negative correlation between inflation and unemployment in data for the United States.

Question 18

According to Friedman and Phelps, which of the following does not influence the economy's unemployment rate in the long run?

A)monetary growth
B)the market power of unions
C)the role of efficiency wages

Question 19

The Phillips curve is the short-run relationship between inflation and unemployment.

Question 20

Friedman and Phelps concluded that there is no reason to think the rate of inflation would, in the long run, be related to the rate of unemployment.

Question 21

The natural rate of unemployment is:

A)the non-acceleration inflation rate of unemployment
B)where the unemployment rate tends towards its normal level
C)beyond the influence of monetary policy
D)all of the above

Question 22

A vertical long-run Phillips curve occurs at the _____.

A)natural rate of unemployment
B)equilibrium interest rate
C)expected inflation rate
D)actual inflation rate

Question 23

Disinflation is defined as:

A)a zero rate of inflation
B)a constant rate of inflation
C)a reduction in the rate of inflation
D)deflation

Question 24

If the long-run Phillips curve shifts to the left, the economy will experience a(n) ____ short-run trade-off between inflation and unemployment.

A)more favourable
B)less favourable
C)indeterminate
D)constant

Question 25

An increase in expected inflation:

A)shifts the short-run Phillips curve to the left
B)increases the unemployment rate along the Phillips curve
C)decreases the unemployment rate along the Phillips curve
D)shifts the short-run Phillips curve to the right

Question 26

If the sacrifice ratio is five, it means that in order to reduce inflation by one percentage point, the economy will experience _____.

A)a reduction of annual output by five percentage points
B)a rise of annual output by five percentage points
C)a reduction of annual output by 0.20 percentage points
D)a rise of annual output by 0.20 percentage points

Question 27

According to the theory of rational expectations, an announced policy of reducing the rate of growth of the money supply will result in people:

A)not changing their forecasts of inflation
B)increasing their forecasts of expected inflation
C)reducing their forecasts of expected inflation
D)doing none of the above

Question 28

If the sacrifice ratio is 5 per cent, reducing the inflation rate from 10 per cent to 5 per cent would require sacrificing _____ per cent of annual output.

A)5
B)10
C)20
D)25

Question 29

If the sacrifice ratio is 5 per cent, then reducing the inflation rate from 12 per cent to 4 per cent would require sacrificing _____ per cent of annual output.

A)5
B)8
C)13
D)40

Question 30

The increase in oil prices in the 2000s was caused primarily by:

A)an increase in demand for oil
B)an increase in supply of oil
C)a decrease in supply of oil
D)a decrease in demand for oil

Question 31

The natural rate of unemployment is:

A)the socially desirable unemployment rate
B)beyond the influence of monetary policy
C)constant over time
D)all of the above

Question 32

See the graph 16-1 below.In the short run, a decrease in the rate of growth of the money supply will move the economy from point K to point ____.NARRBEGIN: 16-1
Graph 16-1

A)G
B)M
C)H
D)L

Question 33

In the short run, the Phillips curve shifts with _____ in the economy.

A)the aggregate demand curve
B)the short-run aggregate supply curve
C)the long-run aggregate supply curve
D)the interest rate target

Question 34

Faced with an adverse supply shock, the economy experiences an aggregate-supply curve shift to the:

A)left, and this shift is associated with a shift in the short-run Phillips curve to the left
B)left, and this shift is associated with a shift in the short-run Phillips curve to the right
C)right, and this shift is associated with a shift in the short-run Phillips curve to the right
D)right, and this shift is associated with a shift in the short-run Phillips curve to the left

Question 35

Rational expectations refers to _____.

A)the theory according to which people optimally use all the information they have, including information about government policies, when forecasting the future.
B)theory explaining the returns in risky assets
C)the theory explaining how the government responds to exogenous shocks to the economy.
D)the theory according to which the central bank establishes the inflation target.

Question 36

If the long-run Phillips curve shifts to the right, the economy will have _____ for any given rate of money growth and inflation.

A)lower unemployment and lower output
B)lower unemployment and higher output
C)higher unemployment and lower output
D)higher unemployment and higher output

Question 37

The sacrifice ratio is:

A)the sum of the inflation and unemployment rates
B)the percentage by which actual output falls below full employment output for every one percentage point that actual unemployment is above the natural rate of unemployment
C)the inflation rate divided by the unemployment rate
D)the number of percentage points of annual output that are lost in the process of reducing inflation by one percentage point

Question 38

Samuelson and Solow believed that the Phillips curve:

A)would shift to the right if the central bank used expansionary monetary policy to reduce unemployment
B)implied that low unemployment was associated with low inflation
C)offered policymakers a menu of possible economic outcomes from which to choose
D)all of the above
E)none of the above

Question 39

According to Friedman and Phelps, policymakers _____.

A)do face a trade-off between inflation and unemployment, but only a temporary one
B)do face a trade-off between inflation and unemployment, but only in the long run
C)do not face a trade-off between inflation and unemployment, but often act as if they do
D)do not face a trade-off between inflation and unemployment, but should act as if they do

Question 40

The long-run Phillips curve is_____ at the _____.

A)vertical; natural rate of unemployment
B)horizontal; natural rate of unemployment
C)vertical; inflation target
D)horizontal; inflation target

Question 41

Economists have various theories of how expectations may be formed.The textbook discusses the theory of rational expectations.Another possibility is that people have adaptive expectations, which means they form their expectations based on recent history.(For example, people might guess that the inflation rate next year will be the same as it was this year.) Would it be easier to eliminate inflation when people have rational expectations or when they have adaptive expectations?

Question 42

The increase in the price of oil in 2010 could be attributed to:

A)speculation over the levels of global reserves
B)reduction in supply of oil
C)increase in the costs of drilling
D)all of the above

Question 43

The equation by Friedman and Phelps of a relationship between the unemployment rate and its natural rate can be summarised as:

A)Unemployment rate = Natural rate of unemployment /(Actual inflation - Expected inflation)
B)Unemployment rate = Natural rate of unemployment - a(Actual inflation - Expected inflation)
C)Unemployment rate = Natural rate of unemployment - Actual inflation
D)Unemployment rate = Natural rate of unemployment - Expected inflation

Question 44

Most economists believe that:

A)there is no short-run trade-off between inflation and unemployment
B)there is a temporary trade-off between inflation and unemployment
C)there is no long-run trade-off between inflation and unemployment
D)both A and B
E)both B and C

Question 45

If the RBA raises its inflation target, how would such change in monetary policy affect the short-run Phillips curve? How about its long-run counterpart?

Question 46

A group of economists offer the theory that the economy will reduce inflation without the cost of _____ if people are rational.

A)high unemployment and low output
B)low unemployment and high output
C)high unemployment and high output
D)low unemployment and low output

Question 47

Suppose that the RBA increases the money supply.What will happen to unemployment in the short run? What will happen to unemployment in the long run?

Question 48

The _____ Phillips curve is downward sloping and the _____ Phillips curve is vertical.

A)short-run; long-run
B)long-run; short-run
C)short-run; medium-run
D)long-run; medium-run

Question 49

If the sacrifice ratio is 6 per cent, then reducing the inflation rate from 10 per cent to 4 per cent would require sacrificing _____ per cent of annual output.

A)6
B)36
C)13
D)40

Question 50

The Phillips curve is:

A)a negative association between the inflation rate and the unemployment rate
B)a negative association between the interest rate and the unemployment rate
C)a positive association between the inflation rate and the unemployment rate
D)a positive association between the growth rate and the unemployment rate

Question 51

Suppose a country is experiencing a hyperinflation.Even a small sacrifice ratio would suggest that it would be incredibly costly for such a country to eliminate inflation.For example, suppose the sacrifice ratio is one, but inflation is running at 5000 per cent per year.Then the sacrifice ratio suggests that it would cost 50 years worth of output to get inflation to zero! This is obviously not right.Why does the sacrifice ratio not provide a good way of measuring the cost of ending a hyperinflation?

Question 52

Explain how a demand shock can affect the unemployment rate in the short run.

Question 53

Most macroeconomic variables - for example, GDP or inflation or unemployment - can be easily measured.Expectations, however, are difficult - perhaps impossible - to measure accurately.Why do macroeconomists give such prominence in their theory to such an elusive variable?

Question 54

Friedman and Phelps concluded that policymakers face a _____ trade-off between inflation and unemployment.

A)Temporary
B)Permanent
C)A and B
D)None of the above

Question 55

Using the theory of rational expectations of inflation, identify how statements made by the government and RBA, could affect the rate of inflation.

Question 56

What is the lesser of two evils - high unemployment or high inflation? Do policy makers have to make this choice all the time? If so, what is the correct choice, according to this chapter?

Question 57

Discuss the role of the sacrifice ratio and illustrate its usefulness in policy making.