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Six Debates over Macroeconomic Policy 8743
25. 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
a. decrease the money supply, which will move output back towards its long-run level.
b. decrease the money supply, which will move output farther from its long-run level.
c. increase the money supply, which will move output back towards its long-run level.
d. increase the money supply, which will move output farther from its long-run level.
26. 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
a. decrease the money supply, which shifts aggregate demand further right.
b. decrease the money supply, which shifts aggregate demand left.
c. increase the money supply, which shifts aggregate demand further right.
d. increase the money supply, which shifts aggregate demand left.
8744 Six Debates over Macroeconomic Policy
27. 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
a. increase the money supply so interest rates rise.
b. increase the money supply so interest rates fall.
c. decrease the money supply so interest rates rise.
d. decrease the moneys supply so interest rates fall
28. 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
a. decrease the money supply, which will move output back towards its long-run level.
b. decrease the money supply, which will move output farther from its long-run level.
c. increase the money supply, which will move output back towards its long-run level.
d. increase the money supply, which will move output farther from its long-run level.
Six Debates over Macroeconomic Policy 8745
29. 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
a. decrease the money supply so interest rates rise.
b. decrease the money supply so interest rates fall.
c. increase the money supply so interest rates rise.
d. increase the money supply so interest rates fall.
30. 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
a. increase the money supply, which causes output to move closer to its long-run equilibrium.
b. increase the money supply, which causes output to move farther from long-run equilibrium.
c. decrease the money supply, which causes output to move closer to its long-run equilibrium.
d. decrease the money supply, which causes output to move farther from long-run equilibrium.
8746 Six Debates over Macroeconomic Policy
31. 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
a. the central bank would have to decrease the money supply which would decrease output.
b. the central bank would have to decrease the money supply which would increase output.
c. the central bank would have to increase the money supply which would decrease output.
d. the central bank would have to increase the money supply which would increase output.
32. 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
a. the central bank would have to decrease the money supply which would decrease output.
b. the central bank would have to decrease the money supply which would increase output.
c. the central bank would have to increase the money supply which would decrease output.
d. the central bank would have to increase the money supply which would increase output.
Six Debates over Macroeconomic Policy 8747
33. 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
a. the central bank would have to raise interest rates which would decrease output.
b. the central bank would have to raise interest rates which would increase output.
c. the central bank would have to reduce interest rates which would decrease output.
d. the central bank would have to reduce interest rates which would increase output.
34. 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?
a. If aggregate demand shifts right from long-run equilibrium, this rule unambiguously implies that
the Fed increases the nominal interest rate.
b. If aggregate supply shifts right from long-run equilibrium at the inflation target, we cannot tell
without more information whether the Fed should increase or decrease the nominal interest
rate.
c. If output is at its natural level, but inflation is above its target, the Fed must increase the
nominal interest rate.
d. If inflation is at its targeted level, but output is above its natural rate, the Fed must decrease the
federal funds rate.
8748 Six Debates over Macroeconomic Policy
35. 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
a. 1/2 percentage point
b. 1 percentage point
c. 1 and 1/2 percentage points
d. 3 and 1/2 percentage points
36. 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
a. 1.5 percentage points
b. 2.5 percentage points
c. 3.5 percentage points
d. 5.5 percentage points
Six Debates over Macroeconomic Policy 8749
37. Some people believe that monetary policy should be made by rule rather than by discretion. One
of their beliefs is that
a. setting a policy rule will limit the abuse of power of policymakers.
b. policymakers can better influence the political business cycle in their favor when following a
policy rule.
c. a policy rule provides policymakers with the greatest flexibility to manage inflation.
d. if the Fed was required to follow a low-inflation policy, the economy would face a less
favorable short-run trade-off between inflation and unemployment.
38. Who did President Jimmy Carter appoint to head the Federal Reserve beginning in 1979?
a. Ben Bernanke
b. Alan Greenspan
c. Paul Volcker
d. Arthur Burns
8750 Six Debates over Macroeconomic Policy
39. Paul Volcker, former chair of the Fed, implemented
a. contractionary policy which increased the popularity of the U.S. president who had appointed
him.
b. contractionary policy which decreased the popularity of the U.S. president who had appointed
him.
c. expansionary policy which increased the popularity of the U.S. president who had appointed
him.
d. expansionary policy which decreased the popularity of the U.S. president who had appointed
him.
40. Which of the following is correct? In the 1990’s
a. the Fed maintained low inflation because it had to follow a policy rule.
b. the Fed maintained low inflation even without being required to follow a policy rule.
c. the Fed was not required to follow a policy rule and let inflation move higher.
d. the Fed was required to follow a policy rule, but it provided the Fed enough discretion that
inflation moved higher.
Six Debates over Macroeconomic Policy 8751
41. An opponent of monetary policy decisions by rule would point to which of the following as
support of his case?
a. time inconsistency of policy
b. flexibility to confront unforeseen circumstances
c. political business cycle
d. the ability to craft rules that account for all possible contingencies in advance
42. Which of the following is an important advantage of discretionary monetary policy?
a. Influencing the political business cycle
b. Flexibility to deal with changing economic conditions
c. Limiting the opportunities for abuse of power by policymakers
d. Avoiding the time inconsistency of policy problem
43. According to the political business cycle, after an election, unless the central bank acts inflation is
likely to
a. have risen. To counter this the central bank would raise interest rates.
b. have risen. To counter this the central bank would lower interest rates.
c. have fallen. To counter this the central bank would raise interest rates.
d. have fallen. To counter this the central bank would lower interest rates.
8752 Six Debates over Macroeconomic Policy
44. As it is usually practiced, inflation targeting sets
a. a specific inflation rate for the central bank to target and prohibits it from deviating from the
target even when some shock pushes inflation away from that number.
b. a specific inflation rate for the central bank to target but allows it to deviate from the target
when some shock pushes inflation away from that number.
c. sets some range of inflation rates for the central bank to target and prohibits it from deviating
from that range even when some shock pushes inflation outside the range.
d. sets some range of inflation rates for the central bank to target but allows it to deviate from
that range when some shock pushes inflation outside the range.
45. The Federal Reserve
a. does not have an inflation target; if it did it would likely be 1% or less.
b. does not have an inflation target; if it did it would likely be in the range of 2%.
c. does have an inflation target; it is 1%.
d. does have an inflation target; it is a range from 1-3%.
Six Debates over Macroeconomic Policy 8753
Multiple Choice – Section 04: Should the Central Bank Aim for Zero Inflation?
1. For the Fed to fully eliminate the costs of inflation, how low does the inflation rate need to be?
a. 0 percent
b. 3 percent
c. 5 percent
d. 6 percent
2. Which of the following is a cost of inflation?
a. shoeleather costs
b. menu costs
c. relative price variability
d. All of the above are correct.
8754 Six Debates over Macroeconomic Policy
3. Which of the following is not a cost of inflation identified by economists?
a. menu costs associated with more frequent adjustment of prices
b. confusion and inconvenience resulting from a changing value of the unit of account
c. reduced price flexibility
d. arbitrary redistributions of wealth associated with dollar-denominated debts
4. Inflation
a. causes people to spend more time reducing money balances. When inflation is unexpectedly high
it redistributes wealth from lenders to borrowers.
b. causes people to spend more time reducing money balances. When inflation is unexpectedly high
it redistributes wealth from borrowers to lenders.
c. causes people to spend less time reducing money balances. When inflation is unexpectedly high
it redistributes wealth from lenders to borrowers.
d. causes people to spend less time reducing money balances. When inflation is unexpectedly high
it redistributes wealth from borrowers to lenders.
Six Debates over Macroeconomic Policy 8755
5. If inflation falls,
a. people choose to put in more effort to keep money balances low. When inflation is unexpectedly
low it redistributes wealth from lenders to borrowers.
b. people choose to put in more effort to keep money balances low. When inflation is unexpectedly
low it redistributes wealth from borrowers to lenders.
c. people choose to put in less effort to keep money balances low. When inflation is unexpectedly
low it redistributes wealth from lenders to borrowers.
d. people choose to put in less effort to keep money balances low. When inflation is unexpectedly
low it redistributes wealth from borrowers to lenders.
6. Higher inflation results in
a. more frequent price changes and increased variability of relative prices.
b. more frequent price changes and decreased variability of relative prices.
c. less frequent price changes and increased variability of relative prices.
d. less frequent price changes and decreased variability of relative prices.
8756 Six Debates over Macroeconomic Policy
7. A reduction in inflation would lead to
a. more frequent price changes and increased variability of relative prices.
b. more frequent price changes and decreased variability of relative prices.
c. less frequent price changes and increased variability of relative prices.
d. less frequent price changes and decreased variability of relative prices.
8. Proponents of zero inflation argue that a successful program to reduce inflation
a. eventually reduces inflation expectations.
b. eventually raises real interest rates.
c. permanently decreases output.
d. permanently raises unemployment.
9. Proponents of zero inflation argue that reducing inflation has
a. permanent costs and temporary benefits.
b. temporary costs and permanent benefits.
c. permanent costs and benefits.
d. temporary costs and benefits.
Six Debates over Macroeconomic Policy 8757
10. A permanent reduction in inflation would
a. permanently reduce menu costs and permanently lower unemployment.
b. permanently reduce menu costs and temporarily raise unemployment.
c. temporarily reduce menu costs and temporarily lower unemployment.
d. temporarily reduce menu costs and temporarily raise unemployment.
11. A permanent reduction in inflation would
a. permanently reduce shoeleather costs and permanently lower unemployment
b. permanently reduce shoeleather costs and temporarily raise unemployment
c. temporarily reduce shoeleather costs and temporarily lower unemployment
d. temporarily reduce shoeleather costs and temporarily raise unemployment
12. An individual would suffer lower losses from an unexpectedly higher inflation rate if
a. she held much currency and owned few bonds.
b. she held much currency and owned many bonds.
c. she held little currency and owned few bonds.
d. she held little currency and owned many bonds.
8758 Six Debates over Macroeconomic Policy
13. An individual would suffer lower losses or maybe even gain from an unexpectedly higher inflation
rate if
a. she held much currency and on net was a lender.
b. she held much currency and on net was a borrower.
c. she held little currency and on net was a lender.
d. she held little currency and on net was a borrower.
14. An individual would suffer higher losses from an unexpectedly higher inflation rate if
a. she held much currency and owned few bonds.
b. she held much currency and owned many bonds.
c. she held little currency and owned few bonds.
d. she held little currency and owned many bonds.
Six Debates over Macroeconomic Policy 8759
15. A permanent reduction in inflation would
a. permanently reduce the frequency of price changes and permanently lower unemployment.
b. permanently reduce the frequency of price changes and temporarily raise unemployment.
c. temporarily reduce the frequency of price changes and temporarily lower unemployment.
d. temporarily reduce the frequency of price changes and temporarily raise unemployment.
16. Paul Volcker's inflation reduction efforts
a. failed to reduce inflation.
b. failed to reduce expected inflation.
c. resulted in the highest unemployment rate since the Great Depression.
d. none of the above are correct.
8760 Six Debates over Macroeconomic Policy
17. In the early 1980’s the Fed tightened monetary policy. Over the next few years
a. inflation remained high and unemployment rose.
b. inflation fell but unemployment rose temporarily.
c. inflation and unemployment fell.
d. inflation and unemployment rose.
18. If a central bank were required to target inflation at zero, then when there was a negative
aggregate supply shock the central bank
a. would have to increase the money supply. This would move unemployment closer to the
natural rate.
b. would have to increase the money supply. This would move unemployment further from the
natural rate.
c. would have to decrease the money supply. This would move unemployment closer to the
natural rate.
d. would have to decrease the money supply. This would move unemployment further from the
natural rate.
Six Debates over Macroeconomic Policy 8761
19. If a central bank were required to target inflation at zero, then when there was an unanticipated
increase in aggregate supply the central bank
a. would have to increase the money supply. This would move unemployment closer to the
natural rate.
b. would have to increase the money supply. This would move unemployment further from the
natural rate.
c. would have to decrease the money supply. This would move unemployment closer to the
natural rate.
d. would have to decrease the money supply. This would move unemployment further from the
natural rate.
20. If a central bank were required to target inflation at zero, then when there was a positive
aggregate supply shock the central bank
a. would have to increase the interest rate. This would move unemployment closer to the natural
rate.
b. would have to increase the interest rate. This would move unemployment further from the
natural rate.
c. would have to decrease the interest rate. This would move unemployment closer to the natural
rate.
d. would have to decrease the interest rate. This would move unemployment further from the
natural rate.
8762 Six Debates over Macroeconomic Policy
21. If a central bank were required to target inflation at zero, then when there was an unanticipated
decrease in aggregate demand the central bank
a. would have to increase the money supply. This would move unemployment closer to the
natural rate.
b. would have to increase the money supply. This would move unemployment further from the
natural rate.
c. would have to decrease the money supply. This would move unemployment closer to the
natural rate.
d. would have to decrease the money supply. This would move unemployment further from the
natural rate.
22. Some countries have had high inflation for a long time. Others have had low or moderate inflation
for a long time. Which of the following, at least in theory, could explain why some countries would
continue to have high inflation?
a. High inflation countries have relatively small sacrifice ratios and so see no need to reduce
inflation.
b. Inflation reduction works best when it is unexpected, and people in high inflation countries
would quickly anticipate any change in monetary policy.
c. In a country where inflation has been high for a long time, people are likely to have found ways
to limit the costs.
d. In a country where inflation has been high for a long time, there are no costs to the inflation.
