Deck 18: Rules for Monetary Policy

Question 1

If a dollar of money is used 5 times in transactions in an economy over the course of a year and the supply of money is $120 billion, what is the volume of total spending in the economy?

A)$5 billion
B)$600 billion
C)$240 billion
D)$20 billion

Answer 1

B

Question 2

The Fed eases policy when it

A)decreases both the money growth and the federal funds rate.
B)decreases the money growth and increases the federal funds rate.
C)increases both the money growth and the federal funds rate.
D)increases the money growth and decreases the federal funds rate.

Answer 2

D

Question 3

Which of the following is an useful indicator of the stance of monetary policy?

A)The income tax rate
B)​The federal funds rate
C)​The exchange rate
D)The rate of unemployment

Answer 3

B

Question 4

When a central bank decreases money growth, the bank is said to_______ monetary policy.

A)tighten
B)loosen
C)?destabilize
D)ease

Question 5

Which of the following is likely to happen if people expect the inflation rate to be high and the central bank follows a tight monetary policy?​

A)The economy will enter into a recession.
B)​The level of economic activity will increase.
C)The actual inflation rate will rise.
D)The federal funds rate will fall.

Question 6

If the money supply is $300 billion, the price level is 1.3, and the real output is 1,300 billion, what is the velocity of money?

A)0.33
B)3
C)5.63
D)300,000

Question 7

People know that the Fed has the incentive to announce that the inflation rate will be 3 percent next year, so people will build 3 percent inflation into their wage negotiations.But then the Fed has the incentive to increase inflation above 3 percent to make the economy grow faster.This type of phenomenon is known as

A)inflation targeting.
B)time inconsistency.
C)McCallum's rule.
D)an expectations trap.

Question 8

When a central bank increases money growth, the bank is said to _____policy.

A)restrict
B)tighten
C)destabilize
D)ease

Question 9

If the velocity of money is 8.2, the money supply is $223 billion, and real output is $958 billion, what is the price level?

A)0.5
B)0.8
C)1.7
D)1.9

Question 10

The equation that says money times velocity equals total spending is known as

A)the national income identity.
B)purchasing-power parity.
C)a covenant.
D)the equation of exchange.

Question 11

If velocity of money is 6, the price level is 1.2, and real output is worth $1,100 billion, what is the money supply?

A)$65 billion
B)$153 billion
C)$220 billion
D)$5,500 billion

Question 12

When the central bank chooses a policy at one date, which leads people to make decisions based on that policy, which then causes the central bank to choose a different policy at a later date, then there is said to be

A)irrational expectations.
B)time inconsistency.
C)a liquidity trap.
D)an expectations trap.

Question 13

The systematic setting of policy according to a formula is known as

A)credibility.
B)an expectations trap.
C)discretionary policy.
D)a rule for monetary policy.

Question 14

From 1991 to 2001, Argentina established commitment by

A)following the Taylor rule.
B)following a strict money growth rule.
C)establishing a currency board.
D)using a system of inflation targeting.

Question 15

Monetarists think that

A)money growth is closely related to inflation in the long run.
B)money demand is unstable in the long run.
C)the central should focus on short run economic fluctuations.
D)the central bank should rely on discretionary policy making.

Question 16

The average number of times a dollar of money is used for transactions over the course of a year is referred to as the

A)money multiplier.
B)velocity of money.
C)money growth rate.
D)extent of exchange.

Question 17

If monetary policy is not set by a rule, it is said to be set by

A)randomization.
B)discretion.
C)credibility.
D)destabilization.

Question 18

Total spending divided by the money supply equals

A)the reserve requirement.
B)the transactions demand for money.
C)the money multiplier.
D)the velocity of money.

Question 19

If the velocity of money in an economy is 7.5, money supply is $350 billion, and the price level is 1.5, the real output is worth

A)​$1,750 billion
B)​$1,200 billion
C)​$2625 billion
D)​$5250 billion

Question 20

The Fed is said to tighten policy when it

A)decreases both the money growth and the federal funds rate.
B)decreases the money growth and increases the federal funds rate.
C)increases both the money growth and the federal funds rate.
D)increases the money growth and decreases the federal funds rate.

Question 21

Which terms in the equation for Taylor rule can be influenced by the government through monetary policy?

A)Inflation gap and interest-rate spread
B)Unemployment gap and interest-rate spread
C)Interest-rate spread and unemployment gap
D)Output gap and inflation gap

Question 22

Which equation best represents the Taylor rule?

A)i = r* + ?^T + {w₁ × [(Y ? Y*)/Y*] × 100} + [w₂ × (? ? ?^T)]
B)i = r* + ? + {w₁ × [(Y ? Y*)/Y*] × 100} + [w₂ × (? ? ?^T)]
C)i = r + ?^T + {w₁ × [(Y ? Y*)/Y*] × 100} + [w₂ × (? ? ?^T)]
D)i = r + ? + {w₁ × [(Y ? Y*)/Y*] × 100} + (w₂ × ?)

Question 23

The rule that is used to set a target for the federal funds rate in response to deviations of real output and inflation from their targets is

A)the Taylor rule.
B)a nonactivist rule.
C)a money-growth rule.
D)Mc Cullum's rule.

Question 24

Why have economists abandoned the use of money-growth rules in the United States?

A)Because the Fed can no longer control the money supply
B)Because the velocity growth rate has been too stable
C)Because of instability in money demand
D)Because money-growth rules are overly activist

Question 25

If the potential output of an economy is worth $440 billion and the actual output during a particular year was $435 billion, the output gap is

A)­​1.14 percent
B)​2.2 percent
C)​­5 percent
D)​1.1 percent

Question 26

Under an activist rule,

A)the growth rate of money supply is greater than the inflation rate.
B)monetary policy is allowed to change over the course of the business cycle.
C)the growth rate of money supply is lower than the inflation rate.
D)monetary policy is not changed over the course of the business cycle.

Question 27

Taylor originally picked ______as the equilibrium real federal funds rate, which was equal to its historical average.

A)1 percent
B)2 percent
C)3 percent
D)4 percent

Question 28

The Taylor rule implies that the nominal federal funds rate should be increased if there is a_____ output gap or a_____ inflation gap.?

A)?positive? positive
B)?positive? negative
C)?negative? positive
D)?negative? negative

Question 29

The Taylor rule is

A)an activist rule.
B)a nonactivist rule.
C)used to set optimal tax rates.
D)used to set the amount of government spending.

Question 30

A money-growth rule that does not respond to the state of the economy is a _____rule.

A)lagging
B)leading
C)nonactivist
D)activist

Question 31

Suppose the economy is thought to be 1 percent below its potential output (i.e., the output gap is −1 percent).The potential output is growing at 4% a year.Suppose the Fed is following the Taylor rule, with an inflation rate of 4 percent over the past year.The equilibrium real fed funds rate is 3 percent, the weight on the output gap is 0.75 and the weigh on the inflation gap is 0.25.The inflation target is 1 percent.What should the federal funds rate be?

A)7 percent
B)8 percent
C)9 percent
D)10 percent

Question 32

The central bank of a country follows the Taylor rule to set its interest rate.If the equilibrium real interest rate rises by 1 percentage point, all other variables remaining unchanged,​

A)the central bank should raise the nominal interest rate by 1 percentage point.
B)the central bank should lower the nominal interest rate by 1 percentage point.
C)the central bank should raise the nominal interest rate by 0.5 percentage points.
D)the central bank should lower the nominal interest rate by 0.5 percentage points.

Question 33

If the growth rate of the money supply is 4 percent, the growth rate of velocity of money is 1 percent, and real output growth is 2 percent, what is the inflation rate?

A)−3 percent
B)−1 percent
C)+1 percent
D)+3 percent

Question 34

Suppose the economy is thought to be 1 percent below potential (i.e., the output gap is −1 percent), when potential output grows 4 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 4 percent over the past year.The equilibrium real federal funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The inflation target is 1 percent.What should the federal funds rate be?

A)4 percent
B)6 percent
C)8 percent
D)12 percent

Question 35

If the growth rate of the money supply is 5 percent, the inflation rate is 2 percent, and real output growth is 2 percent, what is the growth rate of the velocity of money?

A)−5 percent
B)−1 percent
C)+1 percent
D)+5 percent

Question 36

Taylor originally picked _____as the weight on the output gap and _____as the weight on the inflation gap in his rule.

A)1; 1
B)1; 1/2
C)1/2; 1/2
D)1/2; 1

Question 37

A money-growth rule that responds to the state of the economy is____ rule.

A)a lagging
B)a leading
C)a nonactivist
D)an activist

Question 38

If the growth rate of velocity is -2 percent, the growth rate of money supply is 7 percent, and the inflation rate is 3 percent, what is the growth rate of real output?

A)​1 percent
B)​2 percent
C)​3 percent
D)​4 percent

Question 39

Suppose the Fed has set the federal funds rate at 4.5 percent using the Taylor rule.If the inflation rate increases by 1 percentage point and the weight on inflation gap is 0.5, all other variables remain unchanged, the federal funds rate should

A)decrease to 3.5 percent.
B)decrease to 4 percent.
C)increase to 5.5 percent.
D)increase to 5 percent.

Question 40

If a country's potential output is $100 billion and the output gap is 5%, the country's actual output is

A)$500 billion.
B)$20 billion.
C)$95 billion.
D)$105 billion

Question 41

What causes the formation of an expectations trap and how can the Fed prevent one from forming?

Question 42

Which of the following best describes the reason why policymakers do not generally like to commit to following a rule for monetary policy?

A)Because changes to the economy's structure will prevent any rule from working well for long
B)Because rules do not effectively prevent time-inconsistency
C)Because rules without credibility are worse than discretion
D)Because central bankers like to feel important

Question 43

A central bank that is explicit about its goals and plans is said to be

A)obvious.
B)transparent.
C)translucent.
D)opaque.

Question 44

Suppose the Fed follows the Taylor rule.Which of the following is likely to happen if the Fed overestimates potential output​?

A)​The inflation rate will rise.
B)The federal funds rate will fall.​
C)​The money supply will decrease.
D)​The income tax rates will increase.

Question 45

Taylor's rule implies that monetary policy should have been easier than the Fed's actual policy in the

A)1950s
B)1960s
C)1970s
D)1980s

Question 46

Which of the following is a disadvantage of inflation targeting?​

A)​It reduces the flexibility of the central bank.
B)​It makes the goals of the central bank explicit.
C)​It leads to the problem of time inconsistency.
D)​It raises the expected inflation rate.

Question 47

A benefit to policymakers of following rules rather than discretion is

A)they could employ a larger staff of economists.
B)they will contribute to the formation of an expectations trap.
C)they would not be able to pursue time-inconsistent policies.
D)they would gain flexibility in case the economy's structure changed.

Question 48

Suppose the federal funds rate is 6 percent.If the output gap increases by 2 percentage points and the weight on output gap is 0.6, by how much should the federal funds rate increase according to the Taylor rule if all other variables remain unchanged?​

A)It should increase by 0.4 percentage points.
B)It should increase by 0.6 percentage points.
C)It should increase by 2 percentage points.
D)It should increase by 1.2 percentage points.

Question 49

A system in which the central bank attempts to achieve a certain rate of change in the overall price level within some period is referred to as

A)disinflation equilibrium.
B)deflation.
C)inflation targeting.
D)rational expectations trapping.

Question 50

How does a central bank establish credibility?

Question 51

Describe time inconsistency and explain how it can be avoided by a central bank setting monetary policy.

Question 52

In inflation targeting, the range that represents the goal for the inflation rate is known as the

A)target band.
B)optimal range.
C)central tendency.
D)ultimate goal.

Question 53

If the Fed follows the Taylor rule and actual inflation is below the inflation target set by the Fed,

A)​the Fed should reduce the nominal federal funds rate.
B)​the Fed should reduce the supply of money.
C)​the Fed should charge a higher tax rate.
D)​the Fed should spend lesser money.

Question 54

​Which of the following happened as a result of inflation targeting in New Zealand ?

A)​It made the goals of the central bank explicit.
B)​It led to a higher expected inflation rate.
C)It increased the inflation rate in the country.
D)​It lowered the credibility of the central bank.

Question 55

Usually inflation targets are set for a

A)low but positive inflation rate.
B)high and positive inflation rate.
C)negative inflation rate.
D)zero inflation rate.

Question 56

Suppose the economy is thought to be 5 percent below potential (i.e., the output gap is −5 percent), when potential output grows 3 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 6 percent over the past year.The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The inflation target is 1 percent.What should the federal funds rate be?

A)4 percent
B)6 percent
C)8 percent
D)9 percent

Question 57

Suppose the economy is thought to be 1 percent below potential (i.e., the output gap is −1 percent), when potential output grows 4 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 4 percent over the past year.The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The federal funds rate is 8.5 percent.What is the inflation target?

A)0 percent
B)1 percent
C)2 percent
D)3 percent

Question 58

New Zealand was the first country to implement a system of

A)disinflation.
B)deflation.
C)inflation targeting.
D)expectations traps.

Question 59

Why have economists abandoned the use of money-growth rules in the United States? Explain.

Question 60

Central banks that use inflation targeting usually communicate their goals and plans in a document known as the

A)directive.
B)inflation report.
C)target analysis.
D)communique.

Question 61

What are the major advantages and disadvantages of inflation targeting?

Question 62

Suppose the economy is thought to be 2 percent above potential (i.e., the output gap is 2 percent), when potential output grows 4 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 2 percent over the past year.The federal funds rate is currently 3 percent.The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The inflation target is 1 percent.
a.Is the fed funds rate currently too high or too low? By how much? Show your work.
b. Suppose a year has gone by, output is now just 1 percent above potential, and inflation rate was 1.5 percent over the year.What federal funds rate should the Fed now set (assuming the inflation target does not change)?

Question 63

Why are policymakers willing to use rules for monetary policy as general guides, but unlikely to follow such rules blindly?

Question 64

In general, periods in which the Taylor rule suggested tighter monetary policy than the Fed actually put in place are periods of rising inflation.Periods in which the Taylor rule suggested that monetary policy should be easier than the Fed actually put in place are periods of declining inflation.Describe a recent exception to these results.

Question 65

If a shock raises inflation, how fast should the central bank reduce it to its target level?

Question 66

Why does the Taylor rule have such wide appeal?

Question 67

Suppose the economy is thought to be 2 percent below potential (i.e., the output gap is ?2 percent), when potential output grows 4 percent per year.Suppose the Fed is following the Taylor rule, with an inflation rate of 3 percent over the past year.The federal funds rate is currently 3 percent.The equilibrium real fed funds rate is 3 percent and the weights on the output gap and inflation gap are 0.5 each.The inflation target is 1 percent.
a.Is the fed funds rate currently too high or too low? By how much? Show your work.
b.Suppose that all the conditions are the same as described above, except that the output gap is +2 percent instead of ?2 percent.Is the fed funds rate currently too high or too low? By how much? Show your work.
c.Suppose a year has gone by, output is now 3 percent above potential, and the inflation rate was 4.5 percent over the year.What federal funds rate should the Fed now set (assuming the inflation target does not change)? Show your work.

Question 68

What challenges do policymakers and researchers face in using the Taylor rule?

Question 69

Suppose the federal funds rate is 4.4 percent and you know that the Fed is following the Taylor rule.You don't know the Fed's inflation target, but the equilibrium real interest rate is 4 percent, the inflation rate is 3 percent, the weight on the GDP gap is 0.4, the weight on the inflation gap is 0.6 and nominal GDP is 2 percent points below its target.Calculate the Fed's inflation target from this information.

Question 70

Why do monetarists favor the use of a nonactivist rule for monetary policy?