Question 1

When a permanent negative supply shock hits the economy ________.
A)in the long-run,the output gap returns to zero only if the central bank raises interest rates
B)the long-run equilibrium level of output depends on whether and how the central bank responds
C)there is no permanent effect on inflation if the central bank raises interest rates
D)all of the above
E)none of the above

Accepted Answer

The answer of When a permanent negative supply shock hits...

Question 2

If higher inflation ensues from a temporary negative supply shock,and in response,the central bank raises interest rates,then ________.
A)it is likely adopting a policy to stabilize inflation in the short run
B)short-run inflation will fluctuate around (first go higher then go lower than)the long run level of inflation
C)it will need to lower interest rates back to their original values to ensure that inflation returns to its original rate
D)all of the above
E)none of the above

Accepted Answer

Raising interest rates in response to a temporary negative supply shock is a measure to stabilize inflation in the short run, acknowledging that such a policy may cause short-run inflation to fluctuate around its long-run level. Eventually, to ensure inflation returns to its original rate, the central bank will likely need to adjust interest rates back to their original values, making all the provided options correct.

Question 3

A negative shock in aggregate demand will likely result in ________.
A)a short run decrease in output
B)a permanently lower equilibrium inflation rate if the central bank does not respond by lowering interest rates
C)an eventual increase in aggregate supply for any inflation rate if the central bank does not respond by lowering interest rates
D)all of the above
E)none of the above

Accepted Answer

A negative shock in aggregate demand typically results in a short-run decrease in output as firms produce less in response to lower demand. If the central bank does not respond by lowering interest rates, this can lead to a permanently lower equilibrium inflation rate due to decreased demand pressures. Additionally, the negative demand shock can lead to an eventual increase in aggregate supply for any given inflation rate if the central bank does not intervene, as firms adjust their production costs and expectations over time.

Question 4

When a permanent negative supply shock hits the economy,a permanently ________.
A)lower equilibrium level of output ensues if the central bank raises interest rates
B)lower equilibrium level of output ensues if the central bank does not respond
C)higher equilibrium level of inflation ensues if the central bank does not respond
D)all of the above
E)none of the above

Accepted Answer

A permanent negative supply shock, such as a decrease in productivity or an increase in production costs, typically leads to a lower equilibrium level of output because the economy's capacity to produce goods and services is reduced. If the central bank raises interest rates in response, it can further reduce output by making borrowing more expensive and potentially slowing down economic activity. If the central bank does not respond, the negative supply shock can lead to higher prices as the costs of production increase, leading to inflation. Therefore, all of the given outcomes can ensue following a permanent negative supply shock, making D the correct answer.

Question 5

When a temporary negative supply shock hits the economy ________.
A)the divine coincidence does not always hold
B)the divine coincidence holds in the short-run
C)the divine coincidence does not hold in the long-run
D)all of the above
E)none of the above

Accepted Answer

The divine coincidence refers to the situation where stabilizing inflation also stabilizes the output gap. A temporary negative supply shock (such as a sudden increase in oil prices) disrupts this balance because stabilizing inflation under such circumstances would require tightening monetary policy, which could widen the output gap. Therefore, the divine coincidence does not always hold in the face of temporary negative supply shocks.

Question 6

If most shocks to the economy are ________ shocks,then ________.
A)aggregate demand;there is a tradeoff between the dual objectives in the short-run
B)temporary aggregate supply;inflation stabilization policy will not stabilize activity in the short-run
C)temporary aggregate supply;output stabilization policy is consistent with no change in inflation in the long-run
D)all of the above
E)none of the above

Accepted Answer

Temporary aggregate supply shocks, such as changes in oil prices or natural disasters, can cause fluctuations in output and inflation in the short-run. In this case, trying to stabilize inflation through monetary policy may not be effective in stabilizing output. However, output stabilization policies, such as fiscal policy, can help mitigate the negative effects of the shock on the economy.

Question 7

When a temporary negative supply shock hits the economy,then in the short-run ________.
A)if the central bank focuses on stabilizing output,it cannot stabilize inflation
B)if the central bank focuses on stabilizing inflation,it cannot stabilize output
C)the divine coincidence does not hold
D)all of the above
E)none of the above

Accepted Answer

In the short-run, a temporary negative supply shock means that stabilizing output and inflation simultaneously becomes challenging. If the central bank tries to stabilize output, inflation may rise due to increased demand. Conversely, focusing on stabilizing inflation might require tightening monetary policy, which can depress output. The "divine coincidence" refers to the idea that stabilizing inflation inherently stabilizes output, but this does not hold in the case of a supply shock, as the central bank faces a trade-off between the two objectives. Therefore, all of the statements A, B, and C are correct, making D the correct choice.

Question 8

If higher inflation ensues from a temporary negative supply shock,and in response,the central bank raises interest rates,then the resulting decrease in AD will return inflation back to its original level ________.
A)and no further action will be required by the central bank
B)but the ensuing positive output gap will lead to higher inflation once again so further interest rate increases will be required by the central bank to return inflation back to its long run level
C)but the ensuing negative output gap will lead to short-run increases in AS and the central bank will have to "undo" its original interest rate hike in order to return inflation back to its target rate
D)all of the above
E)none of the above

Accepted Answer

If the central bank raises interest rates, it will result in a decrease in AD, which will return inflation to its original level. However, this may also result in a negative output gap and short-run increases in AS. To return inflation to its target rate, the central bank will have to undo its original interest rate hike. Therefore, option C is the correct answer. Options A and B are incorrect as they do not consider the impact of short-run AS changes. Option D is also incorrect as it suggests that all possible outcomes are correct. Option E is incorrect as there is a correct answer.

Question 9

When an aggregate demand shock hits the economy ________.
A)there is no conflict for the central bank between pursuing price or output stability because of the divine coincidence
B)the same long-run equilibrium real interest rate is reached whether the central bank intervenes or not
C)the long-run level of output is unaffected
D)all of the above
E)none of the above

Accepted Answer

An aggregate demand shock affects both inflation and output in the short run, but in the long run, the economy tends to return to its natural level of output and the natural rate of interest, regardless of central bank intervention. This is because in the long-run, prices and wages adjust to restore equilibrium, aligning with the concept of the divine coincidence where stabilizing inflation also stabilizes output.

Question 10

What is the divine coincidence? When and why does it not hold true?

Accepted Answer

The answer of What is the divine coincidence? When and...

Question 11

The time it takes for policymakers to obtain and to understand the data and to change the policy instrument based on that information is known as ________,respectively.
A)the data,recognition,and effectiveness lags
B)the recognition,data,and effectiveness lags
C)the data,recognition,and implementation lags
D)the recognition,implementation,and effectiveness lags
E)the data,implementation,and effectiveness lags

Accepted Answer

The correct sequence is data lag (time to obtain data), recognition lag (time to understand the data), and implementation lag (time to change the policy based on that information).

Question 12

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007.Which of the following is a likely result of this increase in financial frictions?
A)The AD curve likely shifted left which caused a negative output gap.
B)The AD curve likely shifted left causing a negative inflation gap.
C)The AD curve likely shifted left followed by an downward movement along the MP curve to a lower equilibrium interest rate in the short run.
D)all of the above
E)none of the above

Accepted Answer

The increase in financial frictions due to the default on subprime mortgages would likely lead to a decrease in aggregate demand (AD), as borrowing becomes more difficult and expensive, reducing spending and investment. This shift to the left in the AD curve could cause a negative output gap, indicating that actual output is below potential output. It could also lead to a negative inflation gap if the decrease in demand reduces pressure on prices. Additionally, the shift in the AD curve could be followed by a downward movement along the monetary policy (MP) curve to a lower equilibrium interest rate in the short run, as central banks might lower interest rates to stimulate the economy. Therefore, all of the mentioned effects are likely results of the increase in financial frictions.

Question 13

When a permanent negative supply shock hits the economy ________.
A)in the long-run,output is permanently lowered whether the central bank reacts or not
B)inflation decreases in the short-run
C)there is no long-run effect on inflation whether the central bank reacts or not
D)all of the above
E)none of the above

Accepted Answer

A permanent negative supply shock, such as a significant increase in the price of oil, will cause a decrease in output and an increase in prices. This is because the cost of production increases, which leads to lower supply and higher prices. In the long-run, output is permanently lowered, regardless of whether the central bank reacts or not, as the economy adjusts to the shock. Therefore, option A is the correct answer. Option B is incorrect because a negative supply shock leads to higher inflation, not lower. Option C is incorrect because there is a long-run effect on inflation due to the decrease in output.

Question 14

A negative shock in aggregate demand will likely result in no permanent change in ________.
A)output
B)the equilibrium inflation rate if the central bank responds by lowering interest rates
C)aggregate demand,if the central bank responds by lowering interest rates
D)all of the above
E)none of the above

Accepted Answer

The answer of A negative shock in aggregate demand will...

Question 15

If most shocks to the economy are ________ shocks,then ________.
A)aggregate demand;inflation stabilization policy will also stabilize activity in the short-run
B)permanent aggregate supply;inflation stabilization policy will also stabilize activity in the short-run
C)temporary aggregate supply;inflation stabilization policy has no impact on economic activity in the long-run
D)all of the above
E)none of the above

Accepted Answer

The answer of If most shocks to the economy are...

Question 16

A negative shock in aggregate demand will likely result in ________.
A)a permanent change in output,if the central bank responds by lowering interest rates
B)no permanent change in the equilibrium inflation rate,unless the central bank responds by lowering interest rates
C)an eventual increase in aggregate supply for any inflation rate,if the central bank responds by lowering interest rates
D)all of the above
E)none of the above

Accepted Answer

A negative shock in aggregate demand typically results in a temporary decrease in output and can lead to lower inflation or deflation. Central bank interventions, such as lowering interest rates, aim to counteract these effects by stimulating demand. However, these actions do not guarantee a permanent change in output (A is incorrect), nor do they ensure no permanent change in the equilibrium inflation rate without specific conditions (B is incorrect). Additionally, a central bank's response by lowering interest rates primarily affects demand rather than directly causing an increase in aggregate supply for any inflation rate (C is incorrect).

Question 17

-Suppose the economy is in a long-run equilibrium when a temporary,favorable aggregate supply shock occurs.On the graphs above,show what happens to bring the economy back to long-run equilibrium,assuming that there is no policy response.In words,explain why "no response" is the best policy.

Accepted Answer

The answer of 
-Suppose the economy is in a long-run...

Question 18

-Suppose the economy is in a long-run equilibrium when a positive demand shock occurs.On the graphs above,show what happens to bring the economy back to long-run equilibrium,assuming that there is no policy response.In words,describe how the graph would be different,if policy makers did intervene.

Accepted Answer

The answer of 
-Suppose the economy is in a long-run...

Question 19

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007.Which of the following is a likely result of this increase in financial frictions?
A)The AD curve likely shifted left which caused a negative output gap.
B)The AD curve likely shifted left which caused a positive inflation gap.
C)The AD curve likely shifted left which caused an upward movement along the MP curve to a higher general equilibrium interest rate.
D)The AD curve likely did not shift.
E)none of the above

Accepted Answer

The increase in financial frictions due to defaults on subprime mortgages would likely reduce overall spending in the economy, leading to a leftward shift in the Aggregate Demand (AD) curve. This shift would result in a negative output gap, where actual output is less than potential output, reflecting a downturn or recessionary condition in the economy.

Question 20

A negative shock in aggregate demand will likely result in ________.
A)a permanent change in output,unless the central bank responds by lowering interest rates
B)a permanently lower equilibrium inflation rate,unless the central bank responds by lowering interest rates
C)an eventual increase in aggregate supply for any inflation rate,if the central bank responds by lowering interest rates
D)all of the above
E)none of the above

Accepted Answer

A negative shock in aggregate demand, such as a decrease in consumer spending or investment, will lead to a decrease in output and an increase in unemployment in the short run. However, without any intervention, the economy will eventually adjust to a lower equilibrium level of output and prices. This means that the equilibrium inflation rate will be permanently lower. However, if the central bank responds by lowering interest rates, it can stimulate aggregate demand and reduce the negative impact of the shock. This can lead to a shorter and less severe recession, and may prevent the equilibrium inflation rate from permanently decreasing.

Quiz 13: Macroeconomic Policy and Aggregate Demand and Supply Analysis

When a permanent negative supply shock hits the economy ________.

If higher inflation ensues from a temporary negative supply shock,and in response,the central bank raises interest rates,then ________.

A negative shock in aggregate demand will likely result in ________.

When a permanent negative supply shock hits the economy,a permanently ________.

When a temporary negative supply shock hits the economy ________.

If most shocks to the economy are shocks,then .

When a temporary negative supply shock hits the economy,then in the short-run ________.

If higher inflation ensues from a temporary negative supply shock,and in response,the central bank raises interest rates,then the resulting decrease in AD will return inflation back to its original level ________.

When an aggregate demand shock hits the economy ________.

What is the divine coincidence? When and why does it not hold true?

The time it takes for policymakers to obtain and to understand the data and to change the policy instrument based on that information is known as ________,respectively.

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007.Which of the following is a likely result of this increase in financial frictions?

When a permanent negative supply shock hits the economy ________.

A negative shock in aggregate demand will likely result in no permanent change in ________.

If most shocks to the economy are shocks,then .

A negative shock in aggregate demand will likely result in ________.

-Suppose the economy is in a long-run equilibrium when a temporary,favorable aggregate supply shock occurs.On the graphs above,show what happens to bring the economy back to long-run equilibrium,assuming that there is no policy response.In words,explain why "no response" is the best policy.

-Suppose the economy is in a long-run equilibrium when a positive demand shock occurs.On the graphs above,show what happens to bring the economy back to long-run equilibrium,assuming that there is no policy response.In words,describe how the graph would be different,if policy makers did intervene.

Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007.Which of the following is a likely result of this increase in financial frictions?

A negative shock in aggregate demand will likely result in ________.