Deck 15: A Dynamic Model of Economic Fluctuations

Question 1

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.

Answer 1

reducing investment and consumption spending.

Question 2

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

Answer 2

natural

Question 3

In the dynamic model, the supply shock variable, $\nu$ _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

Answer 3

Phillips curve

Question 4

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 5

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

A) i_t - E_t $\pi$ _t
B) i_t - E_t $\pi$ _{t + 1}
C) i_t - $\pi$ _t
D) i_t - $\pi$ _{t + 1}

Question 6

According to the Fisher equation, the real interest, r_t, equals the nominal interest rate, i_t, minus the expected inflation rate, which is written as:

A) E_t $\pi$ _t
B) E_t $\pi$ _t+1
C) E_t+1 $\pi$ _t
D) E_{t + 1} $\pi$ _{t + 1}

Question 7

The current inflation rate, $\pi$ _t, represents the change in the price level between periods:

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

Question 8

The natural rate of interest is the real interest rate:

A) at which the demand for goods and services equals the natural rate of output.
B) that most people anticipate based on their expectations of inflation.
C) at which the natural rate of unemployment equals the natural rate of output.
D) equal to the nominal interest rate minus the natural rate of inflation.

Question 9

Long-run growth ____ the demand for goods and services.

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

Question 10

The nominal interest rate, i_t, is the 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 11

Which of the following would be represented by a negative value of the random demand shock, $\varepsilon$ _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 12

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 13

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

A) i_t - E_t $\pi$ _t
B) i_t - E_t $\pi$ _{t + 1}
C) i_t - $\pi$ _t
D) i_t - $\pi$ _{t + 1}

Question 14

Which of the following would be represented by a positive value of the random demand shock, $\varepsilon$ _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 15

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

Question 16

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

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

Question 17

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 18

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

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

Question 19

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) random demand shock.
D) natural level of output.

Question 20

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 21

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 22

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

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

Question 23

Predetermined variables in a model are treated as if they are essentially:

A) endogenous variables.
B) exogenous variables.
C) parameters.
D) equilibrium conditions.

Question 24

The Taylor rule can be written as FF rate = $\pi$ + 2.0 + 0.5 ( $\pi$ - 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate, $\pi$ is the inflation 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 25

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 26

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 27

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 28

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 29

Which of the following would be represented by a negative value of the random supply shock, $\nu$ _t?

A) an irrational wave of pessimism among investors
B) a decrease in government spending
C) oil price decreases resulting from a breakdown in the cartel
D) a decrease in the central bank's inflation target

Question 30

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, people at time t - 1 forecast the inflation rate in time period t will be:

A) $\pi$ _{t - 2}
B) $\pi$ _{t - 1}
C) $\pi$ _t
D) $\pi$ _{t + 1}

Question 31

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 32

Which of the following would be represented by a positive value of the random supply shock, $\nu$ _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

Question 33

The Taylor rule can be written as FF rate = $\pi$ + 2.0 + 0.5 ( $\pi$ - 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate, $\pi$ is the inflation 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 34

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 35

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, at time t the expected inflation rate at time t + 1 is:

A) $\pi$ _{t - 1.}
B) $\pi$ _t.
C) $\pi$ _{t + 1.}
D) $\pi$ _{t + 2.}

Question 36

The Taylor rule can be written as FF rate = $\pi$ + 2.0 + 0.5 ( $\pi$ - 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate, $\pi$ is the inflation 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 37

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

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

Question 38

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

Question 39

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 40

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 41

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) $r _ { \mathrm { t } } + \pi _ { \mathrm { t } } ^ { * }$
B) r_t + $\pi$ _t
C) $\rho$ + E_t $\pi$ _{t + 1}
D) $\rho$ + r_t

Question 42

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 43

At long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, the demand and supply shocks, $\varepsilon$ _t and $\nu$ _t, equal _____ and current inflation, $\pi$ _t, equals _____.

A) 0; 0
B) 0; $\pi$ _{t - 1}
C) $\pi$ _t; 0
D) $\pi _ { \mathrm { t } } ^ { \mathrm { * } }$ ; $\rho$

Question 44

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 45

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

A) E_t $\pi$ _{t + 1}, expected inflation
B) r_t, real interest rate
C) $\pi$ _t, inflation
D) $\pi$ _t, supply shock

Question 46

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_t $\pi$ _{t + 1}
C) $\pi$ _t, i_t, and E_t $\pi$ _{t + 1}
D) r_t, $\pi$ _t, and i_t

Question 47

The dynamic aggregate supply curve is derived from which of the five equations of the model of aggregate demand and aggregate supply?

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 48

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

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

Question 49

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 50

At long-run equilibrium in the dynamic model of aggregate demand and aggregate supply, which variables will be at their natural levels?

A) inflation and output
B) real and nominal interest rates
C) inflation and the nominal interest rate
D) output and the real interest rate

Question 51

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 52

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

A) Y_t, output
B) $\pi _ { \mathrm { t } } ^ { \mathrm { * } }$ central bank's inflation target
C) r_t, real interest rate
D) E_t $\pi$ _{t + 1}, expected inflation

Question 53

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 54

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 55

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 56

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 57

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 58

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

A) Y_t and $\pi$ _t
B) i_t and r_t
C) E_t $\pi$ _{t + 1} and $\pi$ _t
D) Y_t and r_t

Question 59

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 60

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

A) $\pi$ _t, inflation
B) $\pi _ { \mathrm { t } } ^ { \mathrm { * } }$ central bank's inflation target
C) $\rho$ , the natural rate of interest
D) $\pi$ _{t - 1}, previous period's inflation

Question 61

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, output _____ and inflation _____.

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

Question 62

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 63

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 64

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 65

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 66

The negative relationship between inflation and the quantity of goods and services demanded comes about because of the:

A) Phillips curve.
B) monetary policy rule.
C) assumption of adaptive expectations.
D) Fisher effect.

Question 67

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 68

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 69

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 70

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 71

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 72

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 73

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 74

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 75

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 76

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 77

The dynamic aggregate demand curve is drawn for a given:

A) money supply.
B) real interest rate
C) monetary policy rule.
D) inflation rate.

Question 78

An increase in the central bank's target rate of inflation is represented by:

A) a movement up the DAD curve.
B) a movement down the DAD curve.
C) a rightward shift in the DAD curve
D) a leftward shift in the DAD curve.

Question 79

According to the monetary policy rule (assuming $\theta$ _$\pi$ > 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 80

In the dynamic model of aggregate demand and aggregate supply, holding other factors constant, when the natural level of output increases, then inflation:

A) increases.
B) decreases.
C) remains the same.
D) is zero.