Question 1

Proponents of rational expectations argued that the sacrifice ratio

Accepted Answer

Proponents of rational expectations argued that people are rational and will adjust their expectations quickly if they find anti-inflation policy credible. Therefore, the sacrifice ratio could be low.

Question 2

An economy has a current inflation rate of 7%.If the central bank wants to reduce inflation to 4% and the sacrifice ratio is 2,then how much annual output must be sacrificed in the transition?

Accepted Answer

The sacrifice ratio measures how much output must be sacrificed for a 1% reduction in inflation. In this case, the sacrifice ratio is 2, so for a reduction of 3% (from 7% to 4%), the output must be sacrificed by 2 x 3 = 6%. Therefore, the answer is C, 6%.

Question 3

The experience of the Volcker disinflation of the early 1980s

Accepted Answer

The experience of the Volcker disinflation of the early 1980s generally decreased estimates of the sacrifice ratio. The sacrifice ratio is the amount of GDP that must be forgone to reduce inflation by 1%. The Volcker disinflation involved high interest rates and reduced government spending which caused short-term economic pain but led to lower inflation in the long run. This experience showed that the sacrifice ratio was not as high as previously estimated, leading to a reassessment of macroeconomic policy.

Question 4

If the sacrifice ratio is 2,reducing the inflation rate from 4 percent to 2 percent would

Accepted Answer

The sacrifice ratio of 2 means that for every 1% reduction in inflation, 2% of annual output is lost. Reducing inflation by 2% (from 4% to 2%) would therefore cost 4% of annual output.

Question 5

Suppose that an economy is currently experiencing 10 percent unemployment and 15 percent inflation.If in the process of bringing inflation down by 2 percentage points,real GDP falls by 6 percent for a year,the sacrifice ratio is

Accepted Answer

The answer of Suppose that an economy is currently experiencing...

Question 6

As an economist working for a U.S.government agency you determine that a particular country has a sacrifice ratio of 3.Policy-makers in that country are thinking of lowering the inflation rate from 10% to 4%.Is this sacrifice ratio higher or lower than the typical estimate? From your numbers,what is the amount of output that will be lost for this country to reduce its inflation rate?

Accepted Answer

A sacrifice ratio of 3 is actually lower than the typical estimate which ranges from 5 to 8. To calculate the output loss, we use the formula: 
(Sacrifice ratio / 100) x (initial inflation rate - target inflation rate)2 x potential output 
Substituting the given values: 
(3 / 100) x (10 - 4)2 x 100 = 18% of annual output 
Therefore, the correct answer is D.

Question 7

In 1979,Fed Chair Paul Volcker

Accepted Answer

Paul Volcker believed that decreasing inflation would temporarily decrease output growth. He therefore instituted a tight monetary policy that aimed at reducing inflation by raising interest rates, even if it meant lower economic growth in the short term.

Question 8

Suppose a central bank announced that it was going to make a serious effort to fight inflation.A few years later the inflation rate is lower,but there had been a serious recession.We could conclude with certainty that

Accepted Answer

While it is true that the central bank's efforts to fight inflation may have contributed to the recession, it is impossible to conclude with certainty that the rational expectations hypothesis is either true or false, or that the policymakers lacked credibility. Many factors may have contributed to the outcome, including external shocks, changes in government policies, and broader economic conditions. Therefore, none of the statements presented in the answer choices can be regarded as certain under the given circumstances.

Question 9

The restrictive monetary policy followed by the Fed in the early 1980s

Accepted Answer

The restrictive monetary policy followed by the Fed in the early 1980s led to a significant reduction in inflation, but at the cost of a severe recession. The Fed raised interest rates to reduce inflation, which led to a sharp increase in unemployment and a decline in economic output before inflation finally subsided.

Question 10

The theory by which people optimally use all available information when forecasting the future is known as

Accepted Answer

The theory by which people optimally use all available information when forecasting the future is known as rational expectations. This theory suggests that individuals will use all relevant information, including past experiences and current market conditions, to make predictions about future events. This idea was introduced by economist John F. Muth in the 1960s and has since been widely adopted in economics and finance.

Question 11

If the sacrifice ratio is 4,then reducing the inflation rate from 9 percent to 5 percent would require sacrificing

Accepted Answer

The answer of If the sacrifice ratio is 4,then reducing...

Question 12

Proponents of rational expectations theory argued that,in the most extreme case,if policymakers are credibly committed to reducing inflation and rational people understand that commitment and quickly lower their inflation expectations,the sacrifice ratio could be as small as

Accepted Answer

Proponents of rational expectations theory argued that with credible commitment by policymakers to reducing inflation and rational people quickly adjusting their inflation expectations, the sacrifice ratio could be reduced to zero. This is because expectations play a crucial role in determining economic outcomes, and if people expect lower inflation, they would demand lower wage increases, and businesses would be less likely to raise prices, leading to a smoother and quicker reduction in inflation without the need for large output losses.

Question 13

The consequences of the Volcker disinflation demonstrated that when Volcker announced his intention to reduce inflation quickly,on average the public thought

Accepted Answer

The Volcker disinflation involved the Federal Reserve significantly increasing interest rates to combat inflation. When Volcker announced his intention to reduce inflation quickly, the public was skeptical and believed that inflation would fall, but not by as much or as quickly as Volcker claimed. This was because past attempts to reduce inflation had been unsuccessful, so the public was unsure if the Fed would follow through on their actions or if they could actually have a significant impact on inflation. As it turned out, the Fed was able to successfully reduce inflation, but at a cost of a deep recession in the early 1980s.

Question 14

A country is likely to have a higher sacrifice ratio if

Accepted Answer

A higher sacrifice ratio means that a larger output loss is required to reduce inflation. Longer contracts imply that prices are more rigid and therefore, adjusting to inflation changes takes more time. If people believe the central bank will not reduce inflation, they will likely demand higher wages to compensate for inflation, leading to higher costs for firms and a higher sacrifice ratio.

Question 15

Ultimately,the change in unemployment associated with a change in inflation is due to

Accepted Answer

Unanticipated inflation can temporarily reduce unemployment by lowering real wages, leading firms to hire more workers. However, anticipated inflation is usually factored into wage contracts and prices, so it doesn't affect unemployment.

Question 16

If people believe that the central bank is going to reduce inflation,then

Accepted Answer

If people expect lower inflation, the short-run Phillips curve shifts left, indicating lower inflation for any level of unemployment, and the sacrifice ratio falls because less output is lost in reducing inflation.

Question 17

In the late 1970s,proponents of rational expectations argued that

Accepted Answer

The answer of In the late 1970s,proponents of rational expectations...

Question 18

If the Fed announced a policy to reduce inflation and people found it credible,the short-run Phillips curve would shift

Accepted Answer

If people believed the Fed's policy to reduce inflation, they would expect lower inflation in the future, which would shift the short-run Phillips curve left. This means that for any given unemployment rate, there would be lower inflation. The sacrifice ratio, which is the cost of reducing inflation, would also fall because the shift in the Phillips curve would mean that the Fed could achieve lower inflation with less output loss.

Question 19

The Volcker disinflation

Accepted Answer

The Volcker disinflation caused output to fall, but by less than the typical estimate of the sacrifice ratio suggested. This means that the negative impact on output was not as severe as predicted, possibly due to factors such as expansionary monetary policy or increased productivity. Neither option A nor option B accurately reflects the impact of the Volcker disinflation.

Question 20

Which of the following would tend to shorten recessions associated with anti-inflation policies by central banks?

Accepted Answer

If people adjust their expectations of inflation rapidly and believe central bank policy announcements, it can lead to quicker adjustments in wages and prices, reducing the duration of a recession. Additionally, a rapidly shifting short-run Phillips curve can also help in quickly restoring equilibrium.

Quiz 22: The Short Run Trade Off Between Inflation and Unemployment: The Cost of Reducing Inflation