Economics of Money: Chapter 24

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The Role of Expectations in Monetary Policy
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1

Whether one views the discretionary policies of the 1960s and 1970s as destabilizing or believes the economy would have been less stable without these policies, most economists agree that

  1. A) stabilization policies proved more difficult in practice than many economists had expected.
  2. B) stabilization policies proved not to be inflationary.
  3. C) the nondiscretionary policymakers were right in believing that the private economy is inherently stable.
  4. D) the discretionary policymakers were right in believing that the private economy is inherently stable.

Answer: A

2

The argument that econometric policy evaluation is likely to be misleading if policymakers assume stable economic relationships is known as

  1. A) the monetarist revolution.
  2. B) the Lucas critique.
  3. C) public choice theory.
  4. D) new Keynesian theory.

Answer: B

3

Lucas argues that when policies change, expectations will change thereby

  1. A) changing the relationships in econometric models.
  2. B) causing the government to abandon its discretionary stance.
  3. C) forcing the Fed to keep its deliberations secret.
  4. D) making it easier to predict the effects of policy changes.

Answer: A

4

The rational expectations hypothesis implies that when macroeconomic policy changes

  1. A) the economy will become highly unstable.
  2. B) the way expectations are formed will change.
  3. C) people will be slow to catch on to the change.
  4. D) people will make systematic mistakes.

Answer: B

5

The Lucas critique indicates that

  1. A) advocates of discretionary policies' criticisms of rational expectations models are well-founded.
  2. B) advocates of discretionary policies' criticisms of rational expectations models are not well-founded.
  3. C) expectations are important in determining the outcome of a discretionary policy.
  4. D) expectations are not important in determining the outcome of a discretionary policy.

Answer: C

6

The Lucas critique is an attack on the usefulness of

  1. A) conventional econometric models as forecasting tools.
  2. B) conventional econometric models as indicators of the potential impacts on the economy of particular policies.
  3. C) rational expectations models of macroeconomic activity.
  4. D) the relationship between the quantity theory of money and aggregate demand.

Answer: B

7

The interest rate thought to have the most important impact on aggregate demand is the

  1. A) short-term interest rate.
  2. B) T-bill rate.
  3. C) rate on 90-day CDs.
  4. D) long-term interest rate.

Answer: D

8

A rise in short-term interest rates that is believed to be only temporary

  1. A) is likely to have a significant effect on long-term interest rates.
  2. B) will have a bigger impact on long-term interest rates than if the rise in short-term rates had been permanent.
  3. C) is likely to have only a small impact on long-term interest rates.
  4. D) cannot possibly affect long-term interest rates.

Answer: C

9

According to the Lucas critique, if past increases in the short-term interest rate have always been temporary, then

  1. A) the term-structure relationship using past data will then show only a weak effect of changes in the short-term interest rate on the long-term rate.
  2. B) the term-structure relationship using past data will show no effect of changes in the short-term interest rate on the long-term rate.
  3. C) one cannot predict the term-structure relationship as it depends on expectations.
  4. D) the term-structure relationship using past data will nevertheless show a strong effect of changes in the short-term interest rate on the long-term rate because of a change in the way expectations are formed.

Answer: A

10

A policy in which the money supply is kept growing at a constant rate regardless of the state of the economy is

  1. A) a Taylor rule.
  2. B) a discretionary policy.
  3. C) a policy rule advocated by monetarists.
  4. D) advocated by activists.

Answer: C

11

Arguments for adopting a policy rule include

  1. A) the time-inconsistency problem can lead to poor economic outcomes.
  2. B) discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run.
  3. C) policy makers and politicians cannot be trusted.
  4. D) all of the above.

Answer: D

12

Arguments for adopting a policy rule include

  1. A) discretion avoids the straightjacket that would lock in the wrong policy if the model that was used to derive the policy rule proved to be incorrect.
  2. B) discretion enables policy makers to change policy settings when an economy undergoes structural changes.
  3. C) discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run.
  4. D) all of the above.

Answer: C

13

Arguments for discretionary policies include

  1. A) policy rules can be too rigid because they cannot foresee every contingency.
  2. B) the time-inconsistency problem can lead to poor economic outcomes.
  3. C) discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run.
  4. D) all of the above.

Answer: A

14

Arguments for discretionary policies include

  1. A) policy rules can be too rigid because they cannot foresee every contingency.
  2. B) policy rules do not easily incorporate the use of judgment.
  3. C) discretion avoids the straightjacket that would lock in the wrong policy if the model that was used to derive the policy rule proved to be incorrect.
  4. D) discretion enables policy makers to change policy settings when an economy undergoes structural changes.
  5. E) all of the above.

Answer: E

15

________ imposes a conceptual structure and inherent discipline on policy makers, but without eliminating all flexibility.

  1. A) Constrained discretion
  2. B) A policy rule
  3. C) A discretionary policy
  4. D) The Taylor rule

Answer: A

16

A credible nominal anchor

  1. A) can help overcome the time-inconsistency problem by providing an expected constraint on discretionary policy.
  2. B) can help to anchor inflation expectations, which leads to smaller fluctuations in inflation.
  3. C) is required for a policy rule.
  4. D) all of the above.
  5. E) both A and B.

Answer: E

17

Suppose that there is a positive aggregate demand shock and the central bank commits to an inflation rate target. If the commitment is credible, then

  1. A) the public's expected inflation will remain unchanged.
  2. B) the short-run aggregate supply curve will not shift.
  3. C) over time inflation will fall back down to the inflation target.
  4. D) all of the above.
  5. E) both A and B.

Answer: D

18

Suppose that there is a positive aggregate demand shock and the central bank commits to an inflation rate target. But if the commitment is not credible, then

  1. A) the public's expected inflation will remain unchanged.
  2. B) the short-run aggregate supply curve will rise.
  3. C) over time inflation will fall back down to the inflation target.
  4. D) all of the above.
  5. E) both A and B.

Answer: B

19

Suppose that there is a negative aggregate demand shock and the central bank commits to an inflation rate target. If the commitment is credible, then

  1. A) the public's expected inflation will remain unchanged.
  2. B) the short-run aggregate supply curve will rise.
  3. C) over time inflation will fall.
  4. D) all of the above.
  5. E) both A and C.

Answer: A

20

Suppose that there is a negative aggregate demand shock and the central bank commits to an inflation rate target. But if the commitment is not credible, then

  1. A) the public's expected inflation will remain unchanged.
  2. B) the short-run aggregate supply curve will rise.
  3. C) economic contraction will be worse.
  4. D) all of the above.
  5. E) both B and C.

Answer: E

21

Suppose that there is a negative aggregate supply shock and the central bank commits to an inflation rate target.

  1. A) If the commitment is credible, the public's expected inflation will remain unchanged.
  2. B) Credible policy produces better outcomes on both inflation and output in the short run.
  3. C) Policies that are not credible produce worse economic contraction.
  4. D) all of the above.
  5. E) both A and C.

Answer: D

22

The U.S. government can play an important role in establishing the credibility of anti-inflation policy by

  1. A) demonstrating fiscal responsibility.
  2. B) monitoring the Fed.
  3. C) conducting fiscal policy.
  4. D) all of the above.

Answer: A

23

Approaches to establishing central bank credibility include

  1. A) continued success at keeping inflation under control.
  2. B) central bank independence.
  3. C) appointment of a more conservative central banker.
  4. D) all of the above.

Answer: D

24

Approaches to establishing central bank credibility include

  1. A) continued success at keeping inflation under control.
  2. B) inflation targeting.
  3. C) exchange rate targeting.
  4. D) all of the above.

Answer: D

25

Approaches to establishing central bank credibility include

  1. A) inflation targeting.
  2. B) exchange rate targeting.
  3. C) central bank independence.
  4. D) appointment of a more conservative central banker.
  5. E) all of the above.

Answer: E

26

Approaches to establishing central bank credibility include

  1. A) inflation targeting.
  2. B) nominal GDP targeting.
  3. C) central bank independence.
  4. D) appointment of a more conservative central banker.
  5. E) all of the above.

Answer: E

27

Potential advantages of nominal GDP targeting include

  1. A) it implies that the central bank will respond to slowdowns in the real economy even if inflation is not falling.
  2. B) real GDP growth that is below potential or inflation that is below the inflation objective will encourage more expansionary monetary policy.
  3. C) it focuses not only on controlling inflation but also explicitly on stabilizing real GDP.
  4. D) all of the above.

Answer: D

28

Potential weaknesses of nominal GDP targeting include

  1. A) it requires accurate estimates of potential GDP growth, which are not easy to achieve.
  2. B) it implies that the central bank will respond to slowdowns in the real economy even if inflation is not falling.
  3. C) real GDP growth that is below potential or inflation that is below the inflation objective will encourage more expansionary monetary policy.
  4. D) it focuses not only on controlling inflation but also explicitly on stabilizing real GDP.

Answer: A

29

Potential weaknesses of nominal GDP targeting include

  1. A) it is more complicated to explain to the public than inflation targeting and thus the public might be confused about the objectives of the central bank.
  2. B) it implies that the central bank will respond to slowdowns in the real economy even if inflation is not falling.
  3. C) real GDP growth that is below potential or inflation that is below the inflation objective will encourage more expansionary monetary policy.
  4. D) it focuses not only on controlling inflation but also explicitly on stabilizing real GDP.

Answer: A

30

Potential weaknesses of nominal GDP targeting include

  1. A) it requires accurate estimates of potential GDP growth, which are not easy to achieve.
  2. B) real GDP growth that is below potential or inflation that is below the inflation objective will encourage more expansionary monetary policy.
  3. C) it is more complicated to explain to the public than inflation targeting and thus the public might be confused about the objectives of the central bank.
  4. D) both A and C.

Answer: D

31

Ending the "Great Inflation" era in the 1970s is an example of

  1. A) inflation targeting.
  2. B) exchange rate targeting.
  3. C) central bank independence.
  4. D) appointment of a more conservative central banker.
  5. E) all of the above.

Answer: D


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