Question 1

If the Bank of Canada has discretion to choose its own policy and announces a policy of low inflation,then:
A) the policymaker is required to make the money supply grow at a low rate.
B) private economic agents are sure to believe the announcement because it is credible.
C) private economic actors are likely to discount the policy because the Bank of Canada has an incentive to renege on its policy once expectations are formed.
D) the Bank of Canada is certain to renege on its policy once expectations are formed because then it can lower unemployment with minimum inflation.

Accepted Answer

Private economic actors may discount the policy announcement because the Bank of Canada has an incentive to renege on its policy once expectations are formed. This is known as the time inconsistency problem, where the Bank may choose to deviate from its announced policy in the future for short-term gains. As a result, private economic actors may not fully trust the Bank's commitment to low inflation, leading to potential challenges in achieving and maintaining low inflation.

Question 2

Following the recession of 2008-2009,the Bank of Canada embraced a policy of forward guidance.I.This policy was adopted because the short-term interest rate had fallen to almost zero.II.This policy can be of limited usefulness since households and firms understand that the time-inconsistency problem applies.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

Both statements are true. The Bank of Canada adopted forward guidance as a policy tool after the recession of 2008-2009 because the short-term interest rate had fallen to almost zero. However, the usefulness of the policy may still be limited because households and firms are aware of the time-inconsistency problem that can arise from such policy announcements. Knowing that the central bank may change its mind in the future can reduce the impact of forward guidance on the expectations of economic agents.

Question 3

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.
A) reduce; raise
B) raise; reduce
C) reduce; reduce
D) raise; raise

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 4

In practice,inflation targeting is better considered operating with constrained discretion rather than according to a policy rule because central banks with inflation targets typically:
A) are not allowed to adjust the target in the event of shocks.
B) set the inflation target as a range rather than as a particular number.
C) are not held accountable for achieving their target.
D) must achieve their target regardless of economic conditions.

Accepted Answer

Central banks often set an inflation target as a range to allow flexibility in responding to economic shocks and changing conditions, reflecting a constrained discretion approach rather than a strict policy rule.

Question 5

If the velocity of money varies a great deal,steady growth of the money supply is a(n):
A) ineffective way to stabilize aggregate demand.
B) example of discretionary monetary policy.
C) automatic stabilizer.
D) active policy rule.

Accepted Answer

If the velocity of money varies a great deal, it means that changes in the money supply may not have a predictable or stable impact on aggregate demand. This makes steady growth of the money supply an ineffective way to stabilize aggregate demand. Therefore, choice A is the best answer.

Question 6

Assume that there is a short-run tradeoff between inflation and unemployment,that the central bank desires both low inflation and low unemployment,and that the central bank follows a fixed rule in conducting monetary policy.Initially,households and firms expect high inflation.Following a credible announcement by the central bank of a low-inflation policy,households and firms will ______ the central bank's announcement and ______ their expectations of inflation.
A) believe; lower
B) not believe; not change
C) believe; not change
D) not believe; lower

Accepted Answer

If the central bank's announcement is credible, households and firms will believe the announcement and lower their expectations of inflation. This is because they now expect the central bank to take action to keep inflation low, which will lead to a reduction in inflation expectations. Therefore, option A is the best choice.

Question 7

Monetarists believe all of the following except:
A) fluctuations in the money supply are responsible for most large fluctuations in the economy.
B) the central bank should keep the money supply growing at a steady rate.
C) slow and steady growth of the money supply would yield stable output,employment,and prices.
D) the central bank should adjust the money supply to adjust to various shocks to the economy.

Accepted Answer

Monetarists do not believe that the central bank should adjust the money supply to adjust to various shocks to the economy. They argue that the best way to promote stability and economic growth is through the steady growth of the money supply at a pace that matches the growth of the economy's productive capacity. Monetarists also believe that fluctuations in the money supply are responsible for most large fluctuations in the economy, and that slow and steady growth of the money supply would yield stable output, employment, and prices.

Question 8

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.
A) strongly; strongly
B) strongly; not
C) not; strongly
D) not; not

Accepted Answer

Economic research shows that greater central-bank independence is strongly correlated with lower and more stable inflation. However, the correlation between central-bank independence and average growth and variability of real GDP is not as strong. Therefore, option B is the correct choice as it states that the correlation between central-bank independence and real GDP growth and variability is not strong, while the correlation with inflation is strong.

Question 9

Research indicates that greater central-bank independence is correlated with:
A) higher average growth rates of real GDP.
B) lower rates of unemployment.
C) lower and more stable rates of inflation.
D) less volatility of real GDP.

Accepted Answer

Research indicates that greater central-bank independence is correlated with lower and more stable rates of inflation.

Question 10

As Secretary of the Treasury in the United States,Alexander Hamilton opposed the time-inconsistent policy of:
A) repaying the debt.
B) raising taxes.
C) repudiating the debt.
D) reducing taxes.

Accepted Answer

Alexander Hamilton opposed the time-inconsistent policy of repudiating the debt, which means refusing to repay it. He believed that repaying the debt was essential to establishing the creditworthiness of the United States and creating trust among nations for future borrowing. Repudiating the debt would harm the country's reputation and make it difficult to borrow in the future. Therefore, he proposed a plan to repay the debt by raising taxes and issuing government bonds.

Question 11

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:
A) they believe a constant growth rate of the money supply is the best way to stabilize real GDP or unemployment.
B) if the Bank of Canada chose a target that was not the natural output or the natural unemployment rate,the result would be accelerating inflation or deflation.
C) if the Bank of Canada chose a target for the unemployment rate above the natural rate,the result would be accelerating inflation.
D) if the Bank of Canada chose a target for the unemployment rate below the natural rate,the result would be accelerating deflation.

Accepted Answer

Manipulating the money supply directly to hit a real target can lead to accelerating inflation or deflation if the chosen target is not the natural output or unemployment rate. Therefore, most economists do not advocate this approach. Instead, they believe in a constant growth rate of the money supply as the best way to stabilize real GDP or unemployment.

Question 12

The Canadian policy of taxing old,but not new,oil wells in Alberta in Alberta in the 1970s, I: was an ingenious way to tax oil rigs that were already located within Canada without discouraging exploration for new oil reserves;
II: was ill-conceived since it ignored the time-inconsistency problem.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The statement I is not entirely true as the policy did discourage investment in developing new oil reserves as companies would prefer to produce oil from old wells to avoid the taxation. The statement II is true as the policy did not take into account that a future government may not honor the exemption leading to issues with credibility and time inconsistency.

Question 13

Unlike a monetarist policy rule,an inflation target has the advantage of:
A) eliminating the need to announce the policy target.
B) providing a real target rather than a nominal one.
C) allowing the central bank unlimited discretion.
D) insulating the economy from changes in money velocity.

Accepted Answer

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

Question 14

A time-inconsistency problem in macroeconomic policy can occur when the policymaker:
A) is made to follow a strict and an inflexible rule.
B) has discretion in the short run but follows a rule in the long run.
C) has discretion to act as it seems best in each situation,based on his or her own knowledge and experience.
D) has no discretion.

Accepted Answer

The answer of A time-inconsistency problem in macroeconomic policy can...

Question 15

Assume that there is a short-run tradeoff between inflation and unemployment,that the central bank desires both low inflation and low unemployment,and that the central bank uses discretion in conducting monetary policy.Initially,households and firms expect high inflation.Following an announcement by the central bank of a low-inflation policy,households and firms will ______ the central bank's announcement and ______ their expectations of inflation.
A) believe; lower
B) not believe; not change
C) believe; not change
D) not believe; lower

Accepted Answer

Given the context of discretion in monetary policy and an initial expectation of high inflation, households and firms are likely to doubt the central bank's commitment to a low-inflation policy. This skepticism stems from the central bank's past behavior or the lack of a credible commitment mechanism, leading them to maintain their high inflation expectations.

Question 16

Countries with greater central-bank independence can achieve lower rates of inflation:
A) at the cost of higher levels of unemployment.
B) at the cost of slower growth rates of real GDP.
C) at the cost of greater volatility of real GDP.
D) with no apparent real economic costs.

Accepted Answer

Studies have shown that countries with greater central-bank independence are able to achieve lower rates of inflation without significant negative impacts on real economic outcomes such as unemployment or real GDP growth. Therefore, there are no apparent real economic costs associated with greater central-bank independence.

Question 17

The Bank of Canada's policy of inflation targeting represents I: an additional automatic stabilizer when the economy is hit with demand shocks;
II: an additional automatic stabilizer when the economy is hit with supply shocks.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Accepted Answer

The Bank of Canada's policy of inflation targeting is designed to stabilize demand-side inflation by adjusting the short-term interest rates. As a result, it can act as an automatic stabilizer when the economy is hit with demand shocks (such as a recession). However, inflation targeting does not directly address supply-side shocks, such as an increase in the price of oil or other commodities. Therefore, statement II is not true.

Question 18

Central-bank independence refers to:
A) whether central banks pursue monetary policy by rules or discretion.
B) the situation that occurs when the inside lag of monetary policy is not related to the outside lag.
C) the extent to which automatic stabilizers are relied on to cushion economic volatility.
D) the degree of separation between central-bank decision making and political influence.

Accepted Answer

Central-bank independence refers to the degree of separation between central-bank decision making and political influence. This means that the central bank is able to make decisions based on economic factors rather than political pressures.

Question 19

Policymakers may be better able to achieve their goals using a fixed-policy rule rather than using discretion if they face the problem of:
A) short and predictable inside lags.
B) time-inconsistent policy.
C) short and predictable outside lags.
D) weak automatic stabilizers.

Accepted Answer

A fixed-policy rule would help policymakers overcome time inconsistency problems by committing to a pre-determined policy path and avoiding the temptation to deviate from it. This is particularly relevant when the benefits of deviating from the policy path in the short term may lead to worse outcomes in the long term. Short and predictable inside and outside lags do not necessarily require a fixed-policy rule, and weak automatic stabilizers may be addressed with discretionary policy interventions.

Question 20

Monetary policy rules that target nominal variables would target any of the following except the:
A) price level.
B) money supply
C) unemployment rate.
D) level of nominal GDP.

Accepted Answer

Monetary policy rules that target nominal variables would target the price level, money supply, and level of nominal GDP. However, they would not target the unemployment rate, as it is a real variable. Monetary policy can influence the level of employment in the short run, but in the long run, it is determined by real factors such as productivity and labor market institutions.

Quiz 15: Stabilization Policy

If the Bank of Canada has discretion to choose its own policy and announces a policy of low inflation,then:

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.

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

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

Monetarists believe all of the following except:

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.

Research indicates that greater central-bank independence is correlated with:

As Secretary of the Treasury in the United States,Alexander Hamilton opposed the time-inconsistent policy of:

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:

The Canadian policy of taxing old,but not new,oil wells in Alberta in Alberta in the 1970s, I: was an ingenious way to tax oil rigs that were already located within Canada without discouraging exploration for new oil reserves; II: was ill-conceived since it ignored the time-inconsistency problem.

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

A time-inconsistency problem in macroeconomic policy can occur when the policymaker:

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

The Bank of Canada's policy of inflation targeting represents I: an additional automatic stabilizer when the economy is hit with demand shocks; II: an additional automatic stabilizer when the economy is hit with supply shocks.

Central-bank independence refers to:

Policymakers may be better able to achieve their goals using a fixed-policy rule rather than using discretion if they face the problem of:

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