Question 1

Central-bank independence refers to:

Accepted Answer

Central-bank independence refers to the degree of separation between central-bank decision making and political influence. It is important for central banks to be free from political pressure to make decisions that are in the best interest of achieving their monetary policy goals.

Question 2

Monetarists believe all of the following except:

Accepted Answer

Monetarists generally believe in a fixed rule for money supply growth rather than adjusting it in response to economic shocks.

Question 3

As U.S. Secretary of the Treasury, Alexander Hamilton opposed the time-inconsistent policy of:

Accepted Answer

Alexander Hamilton opposed the time-inconsistent policy of repudiating debt because he believed in maintaining the country's creditworthiness and financial stability.

Question 4

In practice, inflation targeting is better considered as operating with constrained discretion rather than according to a policy rule because central banks with inflation targets typically:

Accepted Answer

Central banks with inflation targets typically set the target as a range rather than a particular number, giving them some flexibility to adjust to shocks or changing economic conditions while still being held accountable for achieving their target. This is why inflation targeting is better considered as operating with constrained discretion rather than according to a strict policy rule.

Question 5

The Phillips curve describing an economy takes the form u = uⁿ - α(π - Eπ). The central bank directly sets the inflation rate to minimize the following loss function, L (u, π) = u + γπ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, π is the inflation rate, Eπ is the expected inflation rate, and α and γ are behavioural response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. In an economy in which the central bank dislikes inflation much more than unemployment:

Accepted Answer

If the central bank dislikes inflation much more than unemployment, it will place a higher weight on minimizing inflation in its loss function, which means γ will be very large.

Question 6

Economic science has provided convincing evidence in favour of the:

Accepted Answer

Economic science has shown that macroeconomic policy is complex and context-dependent, and there is no universally accepted rule that applies in all situations.

Question 7

When a government honours its debt obligations, this is an example of:

Accepted Answer

Honouring debt obligations is a part of fiscal policy, and when it is done consistently, it can be considered a fiscal policy rule.

Question 8

The Phillips curve describing an economy takes the form u = uⁿ - α(π - Eπ). The central bank directly sets the inflation rate to minimize the following loss function, L (u, π) = u + γπ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, π is the inflation rate, Eπ is the expected inflation rate, and α and γ are behavioural response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. The optimal inflation rate when the central bank operates using a fixed rule will be _____. The optimal inflation rate when the central bank operates with discretion will be _____.

Accepted Answer

When the central bank operates with a fixed rule, it sets inflation to minimize the loss function, leading to an optimal inflation rate of 0. With discretion, the central bank considers the trade-off between inflation and unemployment, resulting in an optimal inflation rate of α/(2γ).

Question 9

If the velocity of money varies a great deal, steady growth of the money supply is a(n):

Accepted Answer

If the velocity of money varies greatly, then steady growth of the money supply will not necessarily lead to steady growth in aggregate demand. This means that relying on a steady growth in the money supply as a means of stabilizing the economy is not effective.

Question 10

A situation where policymakers have the incentive to deviate from their initial course of action once other agents in the economy have acted is called a(n):

Accepted Answer

Time-inconsistent policy occurs when policymakers have an initial course of action, but then have an incentive to deviate from it once other agents in the economy have acted. This can occur when policymakers are trying to influence future behavior or outcomes, but may later face political pressure or changing economic circumstances that make it difficult to stick to their initial plan.

Question 11

Unlike a monetarist policy rule, an inflation target has the advantage of:

Accepted Answer

The answer of Unlike a monetarist policy rule, an inflation...

Question 12

If a city passes laws limiting rents on apartments but promises to exempt buildings not yet built:

Accepted Answer

By exempting buildings not yet built, the city is signaling to developers that new construction will be more profitable than existing buildings subject to rent limits. This may discourage builders from renovating or maintaining existing properties, as they will not reap the benefits of the exemption.

Question 13

Monetary policy rules that target nominal variables would target any of the following except the:

Accepted Answer

Monetary policy rules that target nominal variables would target the price level (A), money supply (B), or the level of nominal GDP (D). However, it would not target the unemployment rate (C), as this is a real variable that is determined by factors outside the control of the central bank.

Question 14

Although real variables such as unemployment and real GDP are the best measures of economic performance, most economists do not advocate manipulating money supply directly to hit a real target because:

Accepted Answer

Economists believe that targeting real variables like output or unemployment directly with monetary policy can lead to accelerating inflation or deflation if the targets are not aligned with natural levels.

Question 15

Economic research finds that greater central-bank independence is _____ correlated with lower and more stable inflation as well as _____ correlated with the average growth and variability of real GDP.

Accepted Answer

Economic research has found that greater central-bank independence is strongly correlated with lower and more stable inflation, but there is less evidence supporting a strong correlation with the average growth and variability of real GDP. Therefore, choice B is the most accurate option.

Question 16

The Phillips curve describing an economy takes the form u = uⁿ - α(π - Eπ). The central bank directly sets the inflation rate to minimize the following loss function, L (u, π) = u + γπ². The symbol u denotes the unemployment rates, uⁿ is the natural rate of unemployment, π is the inflation rate, Eπ is the expected inflation rate, and α and γ are behavioural response parameters of the economy. Private agents form their expectations rationally before the central bank sets the inflation rate. Compared to making monetary policy with discretion, the optimal inflation rate will be _____ under a fixed rule and the unemployment rate will be _____.

Accepted Answer

Under a fixed rule, the central bank commits to a policy that avoids the inflation bias present in discretionary policy, leading to lower inflation without affecting the natural rate of unemployment.

Question 17

A monetary policy rule that targets nominal GDP would _____ money growth when nominal GDP rises above the target and _____ money growth when nominal GDP falls below the target.

Accepted Answer

A monetary policy rule that targets nominal GDP would reduce money growth when nominal GDP rises above the target to prevent overheating of the economy, and raise money growth when nominal GDP falls below the target to stimulate economic activity.

Question 18

Assume that the Liberal party always had a policy of high money growth while the Conservative party followed a policy of low money growth, and the economy had a standard Phillips curve. Then, if the two parties took regular terms in office:

Accepted Answer

Under the standard Phillips curve, higher money growth by the Liberal party would lead to higher inflation, but not necessarily a political business cycle, as the parties alternate regularly.

Question 19

Inflation targeting is a monetary policy rule that requires the central bank to adjust _____ in order to attain the desired inflation rate.

Accepted Answer

Inflation targeting involves the central bank adjusting the money supply to influence the inflation rate, aiming to maintain it within a target range. This is done through various monetary policy tools such as interest rates and reserve requirements.

Question 20

Countries with greater central-bank independence can achieve lower rates of inflation:

Accepted Answer

According to research, countries with greater central-bank independence tend to have lower rates of inflation with no apparent real economic costs. In fact, they may even have higher levels of economic growth and lower unemployment rates.

Quiz 16: Alternative Perspectives on Stabilization Policy