Question 1

What is the main policy conclusion of the rational expectations school?  
A) Fiscal policy lags are so long and variable that such policy is worthless, but monetary policy can be helpful. 
B) Monetary policy lags are so long and variable that such policy is worthless, but fiscal policy can be helpful. 
C) Both monetary and fiscal policy can be helpful if firms and households correctly anticipate the plans of policymakers. 
D) Neither monetary nor fiscal policy is helpful if firms and households correctly anticipate the plans of policymakers.

Accepted Answer

The rational expectations school concludes that both monetary and fiscal policy are ultimately ineffective if households and firms can correctly anticipate the plans of policymakers. This is because any attempts to use policy instruments to manipulate the economy will already be factored into household and firm decision-making, leading to outcomes that match predictions made using rational expectations.

Question 2

Which of the following corresponds to a movement downward along a short-run Phillips curve?  
A) The aggregate demand curve shifts rightward, moving up along a short-run aggregate supply curve. 
B) The aggregate demand curve shifts leftward, moving down along a short-run aggregate supply curve. 
C) The short-run aggregate supply curve shifts rightward, moving down along the aggregate demand curve. 
D) The short-run aggregate supply curve shifts leftward, moving up along the aggregate demand curve.

Accepted Answer

A movement downward along a short-run Phillips curve corresponds to a decrease in inflation and an increase in unemployment, which can be caused by a leftward shift of the aggregate demand curve, leading to a movement down along a short-run aggregate supply curve.

Question 3

What did the economist A.W.Phillips believe?  
A) that the Bank of Canada should follow a policy rule because it does NOT know the lag structure 
B) that the Bank of Canada should follow a policy rule to avoid monetary surprises 
C) that there is an inverse relationship between inflation and unemployment 
D) that private sector spending is inherently unstable

Accepted Answer

A.W. Phillips is famous for his Phillips Curve, which describes an inverse relationship between inflation and unemployment.

Question 4

What was one result of the inflation associated with the oil embargoes of the 1970s?  
A) reduced unemployment because aggregate demand increased 
B) reduced unemployment because aggregate demand fell 
C) increased unemployment because aggregate demand increased 
D) increased unemployment because aggregate supply fell

Accepted Answer

The inflation associated with the oil embargoes of the 1970s resulted in reduced aggregate supply, leading to an increase in the cost of production for businesses. As a result, businesses were forced to cut costs, reduce production, and lay off workers, leading to increased unemployment rates. Therefore, option D is the correct answer. The other options are incorrect because they do not align with the economic effects of inflation and reduced aggregate supply.

Question 5

In general, the Bank of Canada has NOT embraced a fixed-growth-rate monetary policy.Why is this the case?  
A) because the Bank of Canada directors would lose their jobs if a fixed-growth-rate monetary policy was adopted 
B) because no influential economists have yet come out in favour of a fixed-growth-rate monetary policy 
C) because the Bank of Canada prefers active fiscal policy 
D) because the Bank of Canada directors believe the economy is too complex and too changeable to make a fixed-growth-rate monetary policy work consistently

Accepted Answer

The Bank of Canada directors believe that the economy is too complex and too changeable to make a fixed-growth-rate monetary policy work consistently. Therefore, they have not embraced a fixed-growth-rate monetary policy. A) is incorrect because the directors' jobs would not be at risk if a fixed-growth-rate policy was adopted. B) is incorrect because the lack of support from influential economists is not the reason why the Bank of Canada has not embraced a fixed-growth-rate monetary policy. C) is incorrect because the Bank of Canada's role is specifically focused on monetary policy, not fiscal policy.

Question 6

What does the initial Phillips curve relationship imply is the opportunity cost of reducing unemployment?  
A) a higher inflation rate 
B) a higher debt 
C) a higher interest rate 
D) a higher foreign exchange rate

Accepted Answer

According to the Phillips curve relationship, there is a trade-off between unemployment and inflation. Therefore, reducing unemployment implies higher inflation, which is the opportunity cost.

Question 7

In the early 1960s, the discovery of the Phillips curve relationship caused economists and policymakers to believe they understood the trade-offs between two particular variables.What are the two variables?  
A) aggregate supply and aggregate demand 
B) inflation and unemployment 
C) monetary policy and fiscal policy 
D) rule-making policy and discretionary policy

Accepted Answer

The two variables are inflation and unemployment. The Phillips curve showed a negative relationship between these two variables, suggesting that policymakers could choose a level of inflation to achieve a particular level of unemployment, or vice versa. However, this relationship has become less reliable over time, with some periods of high inflation and unemployment, known as stagflation, challenging the idea of a stable trade-off between these two variables.

Question 8

What relationship does the Phillips curve illustrate?  
A) the relationship between the price level and the number of workers unemployed 
B) the relationship between the inflation rate and the unemployment rate 
C) the relationship between the unemployment rate and the level of GDP 
D) the relationship between the inflation rate and the supply of money

Accepted Answer

The Phillips curve illustrates the relationship between the inflation rate and the unemployment rate. This curve suggests that as the unemployment rate decreases, inflation increases and vice versa.

Question 9

How will an increase in the expected inflation rate affect the Phillips curve?  
A) The short-run Phillips curve will shift upward and to the right. 
B) The short-run Phillips curve will shift downward and to the left. 
C) The short-run Phillips curve will NOT shift unless the unemployment rate changes. 
D) The short-run Phillips curve will become flatter.

Accepted Answer

An increase in expected inflation rate will shift the short-run Phillips curve upward and to the right because at any given level of unemployment, workers will demand higher wages to compensate for the expected increase in inflation, which will result in higher prices and a higher rate of inflation. This means that the trade-off between inflation and unemployment will be worse, leading to higher levels of inflation at any given level of unemployment.

Question 10

Which of the following best characterizes how economists of the rational expectations school view the economy?  
A) They have no confidence in the ability of workers and firms to observe and react to economic events. 
B) They have great faith in the ability of monetary policymakers to maintain a full employment economy with stable prices. 
C) They believe that effective monetary policy can shift the potential level of output to the right. 
D) They believe workers and firms make decisions based on what they think monetary policy will be in the future.

Accepted Answer

Economists of the rational expectations school believe that individuals (workers and firms) make decisions based on their expectations of future monetary policy. They assume that people have rational expectations about the future and that any policy changes will be anticipated and factored into their decision-making. As a result, they tend to argue that monetary policy has limited ability to stabilize the economy in the short run.

Question 11

According to the rational expectations school, what will be the effect of a correctly anticipated expansionary monetary policy?  
A) Real output will increase in the short run only. 
B) Prices and real output will remain the same. 
C) Prices will decrease and real output will decrease. 
D) A movement toward a higher price level will occur.

Accepted Answer

The rational expectations school posits that if an expansionary monetary policy is correctly anticipated, individuals will adjust their behavior in expectation of higher future prices, leading directly to a movement toward a higher price level without necessarily increasing real output in the short run.

Question 12

What relationship does the Phillips curve show?  
A) the relationship between the interest rate and the inflation rate 
B) the relationship between the inflation rate and the rate of unemployment 
C) the relationship between the unemployment rate and the level of real GDP 
D) the relationship between the growth rate and the inflation rate

Accepted Answer

The Phillips curve shows the relationship between the rate of inflation and the rate of unemployment. It suggests that there is an inverse relationship between these two variables, meaning that as unemployment decreases, inflation increases.

Question 13

Which of the following is illustrated by the short-run Phillips curve?  
A) The economy can have low inflation and low unemployment simultaneously. 
B) The economy can have high inflation and high unemployment simultaneously. 
C) A reduction in unemployment comes at the expense of lower inflation. 
D) A reduction in unemployment comes at the expense of higher inflation.

Accepted Answer

The short-run Phillips curve illustrates that there is an inverse relationship between unemployment and inflation in the short run. As unemployment decreases, the demand for labor increases and wages rise, causing firms to increase their prices to maintain profits. This leads to higher inflation. Therefore, a reduction in unemployment in the short run comes at the expense of higher inflation.

Question 14

Suppose the economy had been operating along a given short-run Phillips curve for several years, and then the economy experienced a year of stagflation.How would the year of stagflation be represented?  
A) as a move upward along the short-run Phillips curve 
B) as a move downward along the short-run Phillips curve 
C) as a point above the short-run Phillips curve 
D) as a point below the short-run Phillips curve

Accepted Answer

A year of stagflation represents a point above the short-run Phillips curve because stagflation involves both high inflation and high unemployment, which is not represented by any point on the short-run Phillips curve. This indicates that the relationship between unemployment and inflation has broken down, which is a characteristic of stagflation.

Question 15

The inflation associated with the oil embargoes of the 1970s illustrated the fallacy of the downward-sloping Phillips curve in the long run.What happened to unemployment during this period?  
A) It decreased. 
B) It increased. 
C) It did NOT change. 
D) It first decreased, and then increased.

Accepted Answer

Unemployment increased during the oil embargo period. The upward pressure on prices caused by the decrease in oil supply resulted in higher inflation rates, while the decrease in aggregate demand caused by the rise in oil prices contributed to higher unemployment rates. This suggests that the Phillips curve relationship between inflation and unemployment only holds in the short run and that in the long-run, there is no trade-off between the two variables.

Question 16

Suppose an economist of the rational expectations school is giving advice to a policymaker.Which of the following is the piece of advice the economist would most likely give?  
A) Do NOT use discretionary policy. 
B) Do NOT use discretionary policy if activity lags are long. 
C) Do NOT use fiscal policy if effectiveness lags are long. 
D) Do NOT use monetary policy if implementation lags are long.

Accepted Answer

Rational expectations economists believe that individuals and markets adjust their behavior based on their expectations of future policies and economic conditions. As a result, they believe that discretionary policy can be ineffective or even counterproductive as it can disrupt these expectations and lead to unintended consequences. Therefore, they would advise against using discretionary policy and instead focus on creating a stable and predictable policy environment.

Question 17

On the Phillips curve, how are the immediate effects of a discretionary increase in government spending represented?  
A) by a rightward shift of the aggregate demand curve 
B) by a rightward shift of the Phillips curve 
C) by a leftward shift of the Phillips curve 
D) by a movement along the Phillips curve

Accepted Answer

The answer of On the Phillips curve, how are the...

Question 18

What does the rational expectations school advocate?  
A) monetarism 
B) Keynesianism 
C) an activist approach to policy 
D) a passive approach to policy

Accepted Answer

The rational expectations school advocates for a passive approach to policy, meaning that the market should be allowed to function on its own without interference from government intervention. This is in contrast to an activist approach to policy, which would involve government intervention to stabilize the economy. Rational expectations also tends to favor monetarism over Keynesianism, emphasizing the importance of controlling the money supply rather than using fiscal policy to stimulate demand.

Question 19

What relationship is portrayed by the short-run Phillips curve?  
A) a direct relationship between total employment and the inflation rate 
B) an inverse relationship between inflation and total employment 
C) a direct relationship between the unemployment rate and the inflation rate 
D) an inverse relationship between the unemployment rate and the inflation rate

Accepted Answer

The short-run Phillips curve portrays an inverse relationship between the unemployment rate and the inflation rate. As the unemployment rate decreases, the demand for labor typically increases, leading to higher wages, and in turn, higher production costs. Firms may then choose to pass on these higher costs to consumers in the form of higher prices, leading to inflation. On the other hand, as the unemployment rate increases, the demand for labor decreases, leading to lower production costs, and lower prices. Thus, there is an inverse relationship between the unemployment rate and the inflation rate, as depicted by the short-run Phillips curve.

Question 20

Why does the rational expectations school advocate the passive rule of a fixed-growth-rate monetary policy?  
A) because the information needed to pursue an active policy is insufficient 
B) because the economy is NOT in bad enough shape to require active intervention 
C) because people render active policy ineffective by figuring out what the policy is going to be and taking actions to offset it 
D) because people prefer to put their major emphasis on an active fiscal policy

Accepted Answer

The rational expectations school argues that people can anticipate and adjust their behavior in response to changes in economic policy. Therefore, any attempt at an active monetary policy would likely be rendered ineffective due to individuals taking actions to offset it. The passive rule of a fixed-growth-rate monetary policy is advocated as it provides stability and predictability for individuals' expectations, which helps to prevent excessive responses to policy changes.

Quiz 16: Macro Policy Debate: Active or Passive

What is the main policy conclusion of the rational expectations school?

Which of the following corresponds to a movement downward along a short-run Phillips curve?

What did the economist A.W.Phillips believe?

What was one result of the inflation associated with the oil embargoes of the 1970s?

In general, the Bank of Canada has NOT embraced a fixed-growth-rate monetary policy.Why is this the case?

What does the initial Phillips curve relationship imply is the opportunity cost of reducing unemployment?

In the early 1960s, the discovery of the Phillips curve relationship caused economists and policymakers to believe they understood the trade-offs between two particular variables.What are the two variables?

What relationship does the Phillips curve illustrate?

How will an increase in the expected inflation rate affect the Phillips curve?

Which of the following best characterizes how economists of the rational expectations school view the economy?

According to the rational expectations school, what will be the effect of a correctly anticipated expansionary monetary policy?

What relationship does the Phillips curve show?

Which of the following is illustrated by the short-run Phillips curve?

Suppose the economy had been operating along a given short-run Phillips curve for several years, and then the economy experienced a year of stagflation.How would the year of stagflation be represented?

The inflation associated with the oil embargoes of the 1970s illustrated the fallacy of the downward-sloping Phillips curve in the long run.What happened to unemployment during this period?

Suppose an economist of the rational expectations school is giving advice to a policymaker.Which of the following is the piece of advice the economist would most likely give?

On the Phillips curve, how are the immediate effects of a discretionary increase in government spending represented?

What does the rational expectations school advocate?

What relationship is portrayed by the short-run Phillips curve?

Why does the rational expectations school advocate the passive rule of a fixed-growth-rate monetary policy?