Question 1

The Federal Reserve

Accepted Answer

The Federal Reserve has an inflation target of 2%. This means that they aim to keep inflation at or around 2% in order to promote price stability and a healthy economy.

Question 2

Assume a central bank follows a rule that requires it to take steps to keep the price level constant. If the price level fell because of a decrease in aggregate demand and an increase in aggregate supply that kept output unchanged, then

Accepted Answer

If the price level fell due to a decrease in aggregate demand and an increase in aggregate supply, then the central bank would need to pursue expansionary monetary policy, which involves reducing interest rates to increase spending and overall aggregate demand. This increase in demand would help to stabilize prices and prevent a further decline in the price level. This policy would also likely increase output since lower interest rates make borrowing cheaper for consumers and businesses, ultimately leading to increased investment and consumption.

Question 3

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate demand shifts right, the central bank must

Accepted Answer

The answer of Suppose that the central bank must follow...

Question 4

Suppose that the central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate supply shifts right, the central bank would have to

Accepted Answer

The answer of Suppose that the central bank is required...

Question 5

Assume a central bank follows a rule that requires it to take steps to keep the price level constant. If the price level rose because of an increase in aggregate demand and a decrease in aggregate supply that kept output unchanged, then

Accepted Answer

If the price level is rising due to an increase in aggregate demand and a decrease in aggregate supply, then the central bank would have to decrease the money supply to keep the price level constant. This would mean that there is less money available for spending, which would decrease aggregate demand and output.

Question 6

Consider the following rule for monetary policy: r = 2 percent +  + 1/2(y - y*)/y* + 1/2(- *), where r is the nominal interest rate, y is real GDP, y* is an estimate of the natural rate of output, π is the inflation rate, and π* is the inflation target. Which of the following statements is not correct?

Accepted Answer

If inflation is at its targeted level, but output is above its natural rate, the rule suggests increasing the nominal interest rate, not decreasing it, to counteract the inflationary pressure from higher output.

Question 7

Some people believe that monetary policy should be made by rule rather than by discretion. One of their beliefs is that

Accepted Answer

Those who believe in monetary policy rules argue that a rule-based approach would limit the abuse of power by policymakers, as it would impose specific guidelines and constraints for monetary policy. This could help ensure transparency, consistency, and accountability in policymaking, thereby reducing the risk of political interference, unfairness, or arbitrary decisions. By contrast, discretionary monetary policy, in which policymakers have more discretion and flexibility to adjust policy as they see fit, could lead to more uncertainty, inconsistency, and politicization of monetary policy, which could harm economic stability and growth. Thus, implementing a monetary policy rule could help reduce the risks and costs associated with discretionary monetary policy, including the temptation to manipulate the economy for political gains or personal interests.

Question 8

For the Fed to fully eliminate the costs of inflation, how low does the inflation rate need to be?

Accepted Answer

In order to fully eliminate the costs of inflation, the inflation rate needs to be zero. Any positive inflation rate would still result in some costs of inflation, such as menu costs or shoe leather costs.

Question 9

Which of the following is an important advantage of discretionary monetary policy?

Accepted Answer

Discretionary monetary policy allows policymakers to adjust policies in response to changing economic conditions, which can help stabilize the economy and promote economic growth. This flexibility is an important advantage of discretionary monetary policy. While influencing the political business cycle, limiting the opportunities for abuse of power by policymakers, and avoiding the time inconsistency of policy problem are all potential advantages of discretionary monetary policy, they are not as important as the flexibility to deal with changing economic conditions.

Question 10

Consider the following rule for monetary policy: r = 2 percent + π + 1/2(y - y*)/y* + 1/2(π - π*), where r is the nominal federal funds rate, y is real GDP, y* is an estimate of the natural rate of output, π is the inflation rate, and π* is the inflation target. Other things the same, if the inflation rate rises by 1 percentage point this rule says the Fed should increase the nominal federal funds rate by

Accepted Answer

The answer of Consider the following rule for monetary policy:...

Question 11

An opponent of monetary policy decisions by rule would point to which of the following as support of his case?

Accepted Answer

Opponents of monetary policy decisions by rule argue that a rule-based approach may not provide flexibility to the central bank to address unforeseen economic circumstances such as financial crises or external shocks. Therefore, they might prefer discretionary policies that allow the central bank to respond to changing economic conditions. However, this argument has to be balanced with the risk of time inconsistency of policies or political business cycle.

Question 12

Paul Volcker, former chair of the Fed, implemented

Accepted Answer

Paul Volcker implemented a contractionary policy that led to high interest rates and a recession in the early 1980s. This policy caused short-term pain, but ultimately helped to curb inflation and stabilize the economy in the long-term. However, this policy also decreased the popularity of the U.S. president who had appointed him, as many people were unhappy with the economic conditions during this time.

Question 13

nominal federal funds rate, y is real GDP, y* is an estimate of the natural rate of output, π is the inflation rate, and π* is the inflation target. Other things the same, if the economy starts at y* and π* and then y rises and exceeds y* by 1% and π rises 2% points above π*, the rule would require the Fed to raise the federal funds rate by

Accepted Answer

According to the Taylor rule, the federal funds rate should increase by 1.5 times the output gap (y-y*) plus 0.5 times the difference between actual inflation (π) and the inflation target (π*). In this scenario, the output gap is 1% above its natural level, so 1.5*1 = 1.5 percentage points. The inflation rate is 2 percentage points above the target, so 0.5*2 = 1 percentage point. Therefore, the Fed should raise the federal funds rate by a total of 2.5 percentage points.

Question 14

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate supply shifts left, the central bank must

Accepted Answer

The answer of Suppose that the central bank must follow...

Question 15

Assume a central bank follows a rule that requires it to take steps to keep the price level constant. If the price level fell because of a decrease in aggregate demand and an increase in aggregate supply that kept output unchanged, then

Accepted Answer

If the central bank wants to keep the price level constant and there is a fall in the price level due to a decrease in aggregate demand and an increase in aggregate supply that kept output unchanged, then the central bank would be required to increase the money supply. This would shift the aggregate demand curve to the right, causing an increase in output which would return the price level to its original level. Therefore, D is the correct answer.

Question 16

Which of the following is correct? In the 1990's

Accepted Answer

During the 1990s, the Fed was not required to follow a specific policy rule, but it still maintained low inflation through its discretion and monetary policy decisions. This is supported by the fact that inflation remained low during this time period, despite the absence of a strict policy rule.

Question 17

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate supply shifts left, the central bank must

Accepted Answer

The answer of Suppose that the central bank must follow...

Question 18

As it is usually practiced, inflation targeting sets

Accepted Answer

The answer of As it is usually practiced, inflation targeting...

Question 19

Who did President Jimmy Carter appoint to head the Federal Reserve beginning in 1979?

Accepted Answer

President Jimmy Carter appointed Paul Volcker to head the Federal Reserve in 1979.

Question 20

According to the political business cycle, after an election, unless the central bank acts inflation is likely to

Accepted Answer

According to the political business cycle theory, governments tend to increase spending and reduce taxes before an election, which leads to increased demand and potential inflationary pressures. If the central bank does not act, inflation is likely to have risen. The central bank would then raise interest rates to counteract this inflation.

Quiz 36: Six Debates Over Macroeconomic Policy

The Federal Reserve

Assume a central bank follows a rule that requires it to take steps to keep the price level constant. If the price level fell because of a decrease in aggregate demand and an increase in aggregate supply that kept output unchanged, then

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate demand shifts right, the central bank must

Suppose that the central bank is required to follow a monetary policy rule to stabilize prices. If the economy starts at long-run equilibrium and then aggregate supply shifts right, the central bank would have to

Assume a central bank follows a rule that requires it to take steps to keep the price level constant. If the price level rose because of an increase in aggregate demand and a decrease in aggregate supply that kept output unchanged, then

Some people believe that monetary policy should be made by rule rather than by discretion. One of their beliefs is that

For the Fed to fully eliminate the costs of inflation, how low does the inflation rate need to be?

Which of the following is an important advantage of discretionary monetary policy?

An opponent of monetary policy decisions by rule would point to which of the following as support of his case?

Paul Volcker, former chair of the Fed, implemented

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate supply shifts left, the central bank must

Assume a central bank follows a rule that requires it to take steps to keep the price level constant. If the price level fell because of a decrease in aggregate demand and an increase in aggregate supply that kept output unchanged, then

Which of the following is correct? In the 1990's

Suppose that the central bank must follow a rule that requires it to increase the money supply when the price level falls and decrease the money supply when the price level rises. If the economy starts from long-run equilibrium and aggregate supply shifts left, the central bank must

As it is usually practiced, inflation targeting sets

Who did President Jimmy Carter appoint to head the Federal Reserve beginning in 1979?

According to the political business cycle, after an election, unless the central bank acts inflation is likely to