Question 1

Starting from full employment at the initial target inflation rate, if there is an adverse inflation shock, then the Federal Reserve must _____ in order to keep inflation at the initial target level.

Accepted Answer

If there is an adverse inflation shock, the Federal Reserve must maintain the initial target inflation rate. This can be done by increasing interest rates, which will reduce aggregate demand and slow down the economy, thereby reducing inflationary pressures. The Fed can also use other monetary policy tools, such as open market operations, to reduce the money supply and reduce inflation. However, the Fed must be careful not to overreact and cause a recession. Therefore, maintaining the initial target inflation rate is the best option. The other options, such as increasing or decreasing the target inflation rate or shifting the short-run aggregate supply curve, may have unintended effects and are not optimal strategies for dealing with an inflation shock.

Question 2

Following an adverse inflation shock the economy will return to potential more rapidly if:

Accepted Answer

If inflationary expectations are anchored, it means that people believe that the central bank will take necessary steps to control inflation. This helps to prevent a spiral of continuously rising prices and reduces the time it takes for the economy to return to its potential output level. Option B is incorrect because if inflationary expectations change quickly, it could lead to increased uncertainty and volatility in the economy, making it harder to restore potential output. Option C and D are also incorrect because it is not desirable for the central bank to frequently accommodate higher inflation or raise its target inflation rate.

Question 3

Policymakers' use of stabilization policy to eliminate output gaps is more appropriate when an economy self corrects very ______ and when the output gap is very ____.

Accepted Answer

D

Question 4

The second round increase in inflation following an adverse supply shock is the result of:

Accepted Answer

The second round increase in inflation following an adverse supply shock typically occurs due to the increase in long-term inflationary expectations by the public. As they expect prices to remain high in the future, they demand higher wages and prices, causing a further increase in inflation.

Question 5

Reduced macroeconomic variability in the U.S. since the 1981 has all of the following benefits EXCEPT:

Accepted Answer

Reduced macroeconomic variability allows the Fed to pursue accommodating policy, as it has more room to maneuver without causing excessive fluctuations in the economy. Thus, option D is not a benefit that reduced macroeconomic variability provides. Options A, B, and C are all benefits of reduced macroeconomic variability.

Question 6

Shocks to aggregate demand ______ require the Fed to choose between inflation and output stability; shocks to aggregate supply ______ require the Fed to choose between inflation and output stability.

Accepted Answer

The answer of Shocks to aggregate demand ______ require the...

Question 7

Shocks to _____ require the Fed to choose between inflation and output stability, while shocks to _____ do not require the Fed to choose between inflation and output stability.

Accepted Answer

Shocks to aggregate supply, such as changes in technology or natural disasters, can lead to both higher prices and lower output in the short run. This puts the Fed in a difficult position, as it must choose between addressing inflation or stabilizing output. On the other hand, shocks to aggregate demand, such as changes in consumer spending or exports, only affect output in the short run and can be stabilized without risking inflation. Shocks to the stock market may have some impact on aggregate demand, but not to the same degree as shocks to aggregate supply.

Question 8

Most economists believe that the reduced variability of inflation in the U.S. is the result of:

Accepted Answer

Most economists believe that the reduced variability of inflation in the U.S. is the result of improved monetary policymaking by the Fed. The Federal Reserve has taken a more cautious and data-driven approach to monetary policy, which has helped to stabilize inflation in the country. Additionally, the Fed has been transparent in communicating its policies and decisions, which has helped to anchor inflation expectations and prevent volatility in the economy.

Question 9

Starting from full employment at the initial target inflation rate, if there is an adverse inflation shock, then the Federal Reserve must _____ in order to keep inflation from becoming permanently higher.

Accepted Answer

If there is an adverse inflation shock, maintaining the initial target inflation rate would require the Federal Reserve to use contractionary monetary policy to reduce aggregate demand and prevent the persistence of the inflationary shock. This could include increasing interest rates and reducing the money supply, shifting the AD curve leftward and countering the upward pressure on prices. Changing the target inflation rate would not address the underlying shock, but would simply result in a higher or lower level of inflation going forward. Shifting the short-run aggregate supply curve up would worsen the inflationary shock by reducing output and potentially increasing prices further.

Question 10

To prevent inflation from becoming permanently higher following an adverse inflation shock the Fed must ____, while to offset the effect of an increase in aggregate demand the Fed must _____.

Accepted Answer

To prevent inflation from becoming permanently higher following an adverse inflation shock, the Fed must maintain the inflation rate target and adjust the real interest rate target to the level at which saving equals investment in the long run. This means that they need to use monetary policy tools such as interest rates to balance the economy and prevent inflation from spiraling out of control. To offset the effect of an increase in aggregate demand, the Fed must also maintain the inflation rate target, but in this case, they need to adjust the real interest rate target to ensure that the economy doesn't overheat.

Question 11

Shocks to aggregate demand _____ require the Fed to choose between inflation and output stability, while shocks to aggregate supply ____ require the Fed to choose between inflation and output stability.

Accepted Answer

Shocks to aggregate demand do not require the Fed to choose between inflation and output stability because the Fed can adjust monetary policy to stabilize both. However, shocks to aggregate supply do require such a choice because stabilizing inflation may worsen output stability and vice versa.

Question 12

Anchored inflationary expectations are beneficial to an economy because they:

Accepted Answer

The answer of Anchored inflationary expectations are beneficial to an...

Question 13

Anchored inflationary expectations are people's expectations of future inflation that:

Accepted Answer

Anchored inflationary expectations do not change if inflation rises temporarily, as people believe that the central bank will take measures to bring inflation back to their target in the long run.

Question 14

People's expectations of future inflation that do not change even if inflation rises temporarily are called _____ inflationary expectations.

Accepted Answer

Anchored inflationary expectations means that people's expectations of future inflation are firmly secured or fixed to a particular level, even if there are short-term changes in the inflation rate. This can be a result of a credible monetary policy or other factors such as social norms or past experiences. The other options (aggregate, average, and autonomous) do not accurately describe this specific concept.

Question 15

Starting from full employment at the initial target inflation rate, if there is an adverse inflation shock, then the Federal Reserve must _____ in order to avoid a recession.

Accepted Answer

The answer of Starting from full employment at the initial...

Question 16

Following an adverse supply shock, people with anchored inflation expectations believe the Fed will:

Accepted Answer

People with anchored inflation expectations believe that the Fed will maintain its target inflation rate despite the supply shock. This expectation is because the Fed's commitment to its target inflation rate helps to anchor people's expectations of future inflation. If the Fed were to raise its target inflation rate, it would signal a lack of commitment to its target and could lead to higher inflation expectations in the future. On the other hand, if the Fed were to lower its target inflation rate, it could lead to a deflationary spiral and damage the economy. Therefore, the most likely outcome is that the Fed will keep its target inflation rate unchanged to maintain its credibility and anchor inflation expectations.

Question 17

To accommodate an adverse inflation shock the Fed must ____, while to offset the effect of an increase in aggregate demand the Fed must _____.

Accepted Answer

To accommodate an adverse inflation shock, the Fed may raise the inflation rate target to allow for higher inflation temporarily. To offset an increase in aggregate demand, the Fed adjusts the real interest rate target to stabilize the economy.

Question 18

The credibility of monetary policy is the:

Accepted Answer

The credibility of monetary policy refers to the degree to which the public believes in the central bank's ability and willingness to achieve its goals, especially with respect to keeping inflation low. This belief is critical for the effectiveness of monetary policy as the public's expectations of future inflation can influence their behavior today. Therefore, the credibility of monetary policy is closely tied to the central bank's ability to anchor inflation expectations over the long run, even if doing so may result in short-run costs.

Question 19

Starting from full employment at the initial target inflation rate, if there is a favorable inflation shock, then the Federal Reserve must _____ in order to return output to potential.

Accepted Answer

The answer of Starting from full employment at the initial...

Question 20

The speed at which an economy returns to potential following an adverse inflation shock depends on:

Accepted Answer

The speed at which an economy returns to potential following an adverse inflation shock depends on the public's expectations of how the Federal Reserve will act. If the public expects that the Federal Reserve will take strong action to combat inflation, such as increasing interest rates, then inflation expectations may be reduced and the economy may return to potential more quickly. On the other hand, if the public expects the Federal Reserve to be more accommodative, inflation expectations may remain high and the economy may take longer to return to potential. The other choices (A, B, and C) may also have an impact on the inflation dynamics of an economy, but they do not directly determine the speed at which the economy returns to potential following an adverse inflation shock.

Quiz 14: Stabilizing the Economy: the Role of the Fed