Question 1

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:
A) nominal rate of interest.
B) target rate of inflation.
C) natural rate of interest.
D) current rate of inflation.

Accepted Answer

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, the real interest rate should be equal to the natural rate of interest, which is the rate consistent with output being at its natural level. This is because at this point, there is no need for expansionary or contractionary monetary policy to achieve the target inflation rate, and interest rates can be set at their natural level to promote economic stability.

Question 2

Expectations of inflation based on recently observed inflation is called the assumption of _____ expectations.
A) natural
B) rational
C) dynamic
D) adaptive

Accepted Answer

Adaptive expectations are based on the idea that people form their expectations of future inflation based on recently observed inflation. This assumes that people do not have complete knowledge or understanding of how the economy works, and that their expectations are limited by their experience. This is in contrast to rational expectations, which assume that people have complete knowledge of the economy and form their expectations based on their understanding of economic fundamentals.

Question 3

Predetermined variables in a model are treated as if they are essentially:
A) endogenous variables.
B) exogenous variables.
C) parameters.
D) equilibrium conditions.

Accepted Answer

Predetermined variables are considered as exogenous variables in a model because they are determined outside the model and cannot be explained by the model itself.

Question 4

The Taylor rule can be written as FF rate = $\pi$ + 2.0 + 0.5 ( $\pi$- 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate, $\pi$ is the inflation rate, and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and GDP is at the natural rate, then according to the Taylor rule, the Fed should set the nominal federal funds rate at _____ percent. A) 2 B) 3 C) 4 D) 5

Accepted Answer

According to the Taylor rule, if inflation is 2% and GDP is at its natural rate, the FF rate = 2.0 + 0.5(2 - 2) + 0.5(0) = 4%.

Question 5

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:
A) forecasts optimally using all available information.
B) recently observed inflation.
C) the central bank's inflation target.
D) the difference between the nominal and real interest rate.

Accepted Answer

The dynamic model of aggregate demand and aggregate supply often assumes that people form expectations of inflation based on recently observed inflation, known as adaptive expectations.

Question 6

According to the Taylor rule, when real GDP is above its natural level, the nominal federal funds rate should be _____, and when inflation is below 2 percent, the nominal federal funds rate should be _____.
A) raised; raised
B) raised; lowered
C) lowered; raised
D) lowered; lowered

Accepted Answer

According to the Taylor rule, when real GDP is above its natural level, the nominal federal funds rate should be raised, and when inflation is below 2 percent, the nominal federal funds rate should be lowered. Therefore, choice B, which says the nominal federal funds rate should be raised when real GDP is above its natural level and lowered when inflation is below 2 percent, is the correct choice.

Question 7

In order to achieve the target for the nominal interest rate established by the monetary policy rule, the central bank adjusts:
A) the inflation rate.
B) the natural rate of interest.
C) the money supply.
D) the inflation target.

Accepted Answer

The central bank adjusts the money supply to achieve the target for the nominal interest rate. By changing the money supply, they can influence the interest rate banks charge to lend to each other and to consumers, ultimately affecting the overall nominal interest rate. Adjusting the inflation rate, natural rate of interest, or inflation target may be factors considered when setting the target for the nominal interest rate, but they are not the mechanisms directly used to make adjustments.

Question 8

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate increases when inflation ____ its target, or output ____ its natural level.
A) rises above; rises above
B) rises above; falls below
C) falls below; falls below
D) falls below; rises above

Accepted Answer

According to the monetary policy rule, when inflation rises above its target, the central bank will increase the nominal interest rate to make the real interest rate higher. This is intended to slow down economic growth and reduce inflation. Similarly, if output or real GDP rises above its natural level, the central bank will increase the interest rate to cool down the economy and bring output back to its potential level. Therefore, the correct choice is A, where the real interest rate increases when inflation rises above its target or output rises above its natural level.

Question 9

Which of the following would be represented by a negative value of the random supply shock, $\nu$_t? A) an irrational wave of pessimism among investors B) a decrease in government spending C) oil price decreases resulting from a breakdown in the cartel D) a decrease in the central bank's inflation target

Accepted Answer

A negative value of the random supply shock, as represented by F1F1F1S1F1F1F10_t, corresponds to a decrease in the supply of goods and services. A breakdown in the cartel would lead to a decrease in oil prices, which would reduce the supply of goods and services in the economy. The other answer choices do not necessarily involve a decrease in supply.

Question 10

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, people at time t - 1 forecast the inflation rate in time period t will be: A) $\pi$_t_-₂ B) $\pi$_t_-₁ C) $\pi$_t D) $\pi$_{t + 1}

Accepted Answer

In adaptive expectations, people base their forecast of future inflation on the most recent past inflation rate, which is at time t-1.

Question 11

To follow a monetary policy rule, the central bank raises the nominal interest rate by:
A) raising the inflation target.
B) decreasing the money supply.
C) increasing the GDP gap.
D) decreasing inflation expectations.

Accepted Answer

According to the Taylor Rule, the central bank should adjust the nominal interest rate in response to deviations of inflation from its target and deviations of output from potential. To reduce inflation, the central bank should raise the nominal interest rate by decreasing the money supply. Option A is incorrect because raising the inflation target would lead to higher inflation, which is contrary to the goal of reducing inflation. Option C is incorrect because increasing the GDP gap (the difference between actual and potential GDP) would indicate an overheated economy and the need to raise interest rates to cool it down, but the question asks about reducing inflation. Option D is incorrect because decreasing inflation expectations could make it more difficult for the central bank to achieve its inflation target, but it would not directly lead to a change in the nominal interest rate.

Question 12

Which of the following would be represented by a positive value of the random supply shock, $\nu$_t? A) an irrational wave of optimism among investors B) an increase in government spending C) widespread drought leading to large increases in food prices. D) an increase in the central bank's inflation target

Accepted Answer

A positive value of the random supply shock (F1F1F1S1F1F1F10_t) represents a sudden increase in the cost of production, such as a widespread drought leading to large increases in food prices. This would cause a decrease in supply and an upward shift in the supply curve, resulting in a higher equilibrium price and lower equilibrium quantity. Options A, B, and D do not directly relate to a supply shock.

Question 13

The Taylor rule can be written as FF rate =  $\pi$ + 2.0 + 0.5 ( $\pi$- 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate,  $\pi$ is the inflation rate, and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 2 percent and the GDP gap is -2 percent, then according to the Taylor rule, the Fed should set the nominal federal funds rate at _____ percent.
A) 2
B) 3
C) 4
D) 5

Accepted Answer

The Taylor rule formula becomes: FF rate = 2 + 0.5(2 - 2) + 0.5(-2) = 2 + 0 - 1 = 1%. However, the base rate is 2%, so the final rate is 3%.

Question 14

The interest rate at which banks make loans to other banks is called the:
A) federal funds rate.
B) prime rate.
C) Federal Reserve discount rate.
D) Treasury bill rate.

Accepted Answer

The federal funds rate is the interest rate at which banks lend money to each other overnight to meet reserve requirements set by the Federal Reserve. This rate is set by market forces and is influenced by the current supply and demand for funds in the banking system.

Question 15

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, at time t the expected inflation rate at time t + 1 is: A) $\pi$_t_-_1. B) $\pi$_t. C) $\pi$_{t + 1.} D) $\pi$_{t + 2.}

Accepted Answer

The adaptive expectations hypothesis suggests that agents form their expectations of future inflation based on past inflation rates. Therefore, the expected inflation rate at time t+1 would be based on the inflation rate at time t, which aligns with option B.

Question 16

The Taylor rule can be written as FF rate =  $\pi$ + 2.0 + 0.5 ( $\pi$ - 2.0) + 0.5(GDP gap), where FF rate is the nominal federal funds rate,  $\pi$ is the inflation rate, and the GDP gap is the percentage deviation of real GDP from its natural level. If inflation is 4 percent and the GDP gap is 2 percent, then according to the Taylor rule, the Fed should set the nominal federal funds rate at _____ percent.
A) 4
B) 8
C) 10
D) 12

Accepted Answer

The answer of The Taylor rule can be written as...

Question 17

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate _____ when inflation is above its target, and the real interest rate _____ when output is below its natural level.
A) rises; falls
B) rises; rises
C) falls; falls
D) falls; rises

Accepted Answer

When inflation is above its target, the central bank increases the nominal interest rate to reduce demand and cool down the economy, which in turn raises the real interest rate (nominal interest rate minus inflation rate). Similarly, when output is below its natural level, the central bank cuts the nominal interest rate to stimulate demand and boost the economy, which in turn lowers the real interest rate. Therefore, the real interest rate rises when inflation is high and falls when output is low.

Question 18

According to the Taylor rule, when real GDP is below its natural level, the nominal federal funds rate should be _____, and when inflation exceeds 2 percent, the nominal federal funds rate should be _____.
A) raised; raised
B) raised; lowered
C) lowered; raised
D) lowered; lowered

Accepted Answer

According to the Taylor rule, when real GDP is below its natural level, the nominal federal funds rate should be lowered to stimulate borrowing and investment, thereby boosting economic activity. When inflation exceeds 2 percent, the nominal federal funds rate should be raised to reduce spending and cool down the economy. Therefore, the correct option is C, which states that the nominal federal funds rate should be lowered when real GDP is below its natural level and raised when inflation exceeds 2 percent.

Question 19

The monetary policy rule specified in the dynamic model of aggregate demand and aggregate supply indicates that the central bank adjusts interest rates in response to fluctuations in:
A) inflation expectations.
B) money supply and money demand.
C) inflation and output.
D) nominal and real exchange rates.

Accepted Answer

According to the dynamic model of aggregate demand and aggregate supply, the monetary policy rule specifies that the central bank adjusts interest rates in response to fluctuations in inflation and output. This is because the central bank's main goal is to achieve price stability and full employment, which are both dependent on the level of inflation and output in the economy. Therefore, the central bank uses monetary policy tools such as adjusting interest rates to influence these variables and ultimately achieve its policy goals.

Question 20

John Taylor's rule for setting the federal funds rate proposes increasing the nominal federal funds rate as inflation _____ and the GDP gap _____.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

Accepted Answer

John Taylor's rule suggests that the federal funds rate should be increased when inflation rises and when the GDP gap (the difference between actual and potential GDP) increases, indicating an overheating economy.

Quiz 15: A Dynamic Model of Economic Fluctuations

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:

Expectations of inflation based on recently observed inflation is called the assumption of _____ expectations.

Predetermined variables in a model are treated as if they are essentially:

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:

According to the Taylor rule, when real GDP is above its natural level, the nominal federal funds rate should be _, and when inflation is below 2 percent, the nominal federal funds rate should be _.

In order to achieve the target for the nominal interest rate established by the monetary policy rule, the central bank adjusts:

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate increases when inflation its target, or output its natural level.

Which of the following would be represented by a negative value of the random supply shock, $\nu$ _t?

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, people at time t - 1 forecast the inflation rate in time period t will be:

To follow a monetary policy rule, the central bank raises the nominal interest rate by:

Which of the following would be represented by a positive value of the random supply shock, $\nu$ _t?

The interest rate at which banks make loans to other banks is called the:

In the specification of adaptive expectation used in the dynamic model of aggregate demand and aggregate supply, at time t the expected inflation rate at time t + 1 is:

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate _ when inflation is above its target, and the real interest rate _ when output is below its natural level.

According to the Taylor rule, when real GDP is below its natural level, the nominal federal funds rate should be _, and when inflation exceeds 2 percent, the nominal federal funds rate should be _.

The monetary policy rule specified in the dynamic model of aggregate demand and aggregate supply indicates that the central bank adjusts interest rates in response to fluctuations in:

John Taylor's rule for setting the federal funds rate proposes increasing the nominal federal funds rate as inflation _ and the GDP gap _.