Six Debates over Macroeconomic Policy 8723
5. Supporters of using government expenditures to respond to recession
a. argue that monetary policy should be used first. To respond to a recession the Fed would
increase the money supply.
b. argue that monetary policy should be used first. To respond to a recession the Fed would
decrease the money supply.
c. argue that monetary policy should be used only after fiscal policy has been used. To respond to
a recession the Fed would increase the money supply.
d. argue that monetary policy should be used only after fiscal policy has been used. To respond to
a recession the Fed would decrease the money supply.
6. Stimulus spending in 2009 was used for
a. building roads and bridges.
b. providing aid to local and state governments.
c. making payments to the unemployed.
d. All of the above are correct.
8724 Six Debates over Macroeconomic Policy
7. Which of the following is true of stimulus policy enacted in 2009?
a. We can be sure that it reduced the severity of the recession because the recession was less
severe than the Great Depression.
b. We can be sure that it reduced the severity of the recession even though the recession was
more severe than the Great Depression.
c. We can not be sure that it reduced the severity of the recession, but the recession was less
severe than the Great Depression.
d. We can not be sure that it reduced the severity of the recession because the recession was
more severe than the Great Depression.
8. According to traditional Keynesian analysis, if the economy is in a recession, the government can
move it back towards full employment by
a. cutting taxes and increasing expenditures. The effect of the tax cut is larger.
b. cutting taxes and increasing expenditures. The effect of the tax cut is smaller.
c. raising taxes and decreasing expenditures. The effect of the tax increase is larger.
d. raising taxes and decreasing expenditures. The effect of the tax increase is smaller.
Six Debates over Macroeconomic Policy 8725
9. According to computer estimates using a traditional macroeconomic model, the Obama
administration found that the multiplier for tax cuts and government expenditures were
respectively
a. .99 and 1.59.
b. 1.59 and .99
c. 1.3 and 1.7
d. 1.7 and 1.3
10. In which cases were tax cuts followed by robust growth?
a. the ones of the Kennedy administration in 1964 and the ones of the Reagan administration in
1981
b. the ones of the Kennedy administration in 1964 but not the ones of the Reagan administration in
1981
c. the ones of the Reagan administration in 1981 but not the ones of the Kennedy administration in
1964
d. neither the ones of the Kennedy administration in 1964 nor the ones of the Reagan
administration in 1981
8726 Six Debates over Macroeconomic Policy
11. Suppose a tax cut affected aggregate demand and aggregate supply. The shift in aggregate supply
would make the
a. price level and real GDP change by more than otherwise.
b. price level change by more than otherwise and real GDP change by less than otherwise.
c. price level change by less than otherwise and real GDP change by more than otherwise.
d. price level and real GDP change by more than otherwise.
12. Which of the following can tax cuts influence?
a. Aggregate demand
b. Aggregate supply
c. Investment spending
d. All of the above
13. Which of the following can tax cuts influence?
a. aggregate demand and aggregate supply
b. aggregate demand but not aggregate supply
c. aggregate supply but not aggregate demand
d. neither aggregate demand nor aggregate supply
Six Debates over Macroeconomic Policy 8727
14. Suppose a tax cut affects aggregate demand and aggregate supply. Which of the shifts raise real
GDP?
a. both the shift of aggregate demand and the shift of aggregate supply
b. the shift of aggregate demand, but not the shift of aggregate supply
c. the shift of aggregate supply, but not the shift of aggregate demand
d. neither the shift of aggregate demand nor the shift of aggregate supply
15. Suppose a tax cut affects aggregate demand and aggregate supply. Which of the shifts raise the
price level?
a. both the shift of aggregate demand and the shift of aggregate supply
b. the shift of aggregate demand, but not the shift of aggregate supply
c. the shift of aggregate supply, but not the shift of aggregate demand
d. neither the shift of aggregate demand nor the shift of aggregate supply
8728 Six Debates over Macroeconomic Policy
16. Which of the following is correct?
a. Well designed tax cuts can increase investment which fluctuates more than consumption over
the business cycle.
b. Well designed tax cuts can increase investment but it fluctuates less than consumption over the
business cycle.
c. Tax cuts have little effect on investment which fluctuate more than consumption over the
business cycle.
d. Tax cuts have little effect on investment but it fluctuates less than consumption over the
business cycle
17. Which of the following is correct? Investment tax credits
a. can increase investment, but stimulating investment is not a key to ending a recession.
b. can increase investment, which is a key to ending a recession.
c. can not increase spending on investment goods, but stimulating investment is not a key to
ending a recession.
d. can not increase spending on investment goods, but stimulating investment is a key to ending a
recession.
Six Debates over Macroeconomic Policy 8729
18. Tax cuts
a. can easily target investment spending, but investment spending falls by only a small percentage
during recessions.
b. can easily target investment spending, which falls by a large percentage during recessions.
c. cannot easily target investment spending, but investment spending falls by only a small
percentage during recessions.
d. cannot easily target investment spending, which falls by a large percentage during recessions.
19. An increase in government expenditures may lead people to expect that in the future taxes will
rise and create greater distortions. By themselves these changes in expectations lead people to
a. raise both consumption and investment.
b. raise consumption but reduce investment.
c. raise investment but reduce consumption.
d. reduce both consumption and investment.
20. As compared to government spending, a tax cut is likely to affect aggregate demand
a. more quickly but is more likely to be spent on projects with little benefit.
b. more quickly and is less likely to be spent on projects with little benefit.
c. less quickly but is less likely to be spent on projects with little benefit.
d. less quickly and is more likely to be spent on projects with little benefit.
8730 Six Debates over Macroeconomic Policy
21. As compared to a tax cut, an increase in government expenditures is likely to affect aggregate
demand
a. more quickly but is more likely to be spent on projects with little benefit.
b. more quickly and is less likely to be spent on projects with little benefit.
c. less quickly but is less likely to be spent on projects with little benefit.
d. less quickly and is more likely to be spent on projects with little benefit.
22. As opposed to an increase in government expenditures, a tax cut
a. is likely to impact spending faster and according to traditional theory has a larger multiplier.
b. is likely to impact spending faster, but according to traditional theory has a smaller multiplier.
c. is likely to impact spending with a longer lag, but according to traditional theory has a larger
multiplier.
d. is likely to impact spending with a longer lag and according to traditional theory has a smaller
multiplier
Six Debates over Macroeconomic Policy 8731
23. An increase in government spending financed by borrowing changes people’s expectations about
future taxation such that current consumption expenditures
a. fall. The increase in expenditures makes it likely that future taxes will create smaller distortions.
b. fall. The increase in expenditures makes it likely that future taxes will create larger distortions.
c. rise. The increase in expenditures makes it likely that future taxes will create smaller
distortions.
d. rise. The increase in expenditures makes it likely that future taxes will create larger distortions.
24. Which of the following would those in favor of increasing government spending rather than
decreasing taxes to prop up aggregate demand probably not agree with?
a. Traditional Keynesian analysis indicates that increases in government purchases are a more
potent tool than decreases in taxes for increasing aggregate demand.
b. Increased government spending on “shovelready” projects can be helpful to boost aggregate
demand.
c. Increases in government spending offer a greater “bang for the buck” than decreases in taxes.
d. When the government gives a dollar in tax cuts to a household, that dollar immediately and fully
adds to aggregate demand.
8732 Six Debates over Macroeconomic Policy
25. Which of the following is not a valid point in debating the merits of increasing government
expenditures or cutting taxes during a recession?
a. A cut in the marginal tax rate increases the incentives to find a job and work longer hours.
b. Consumers will save a portion of a tax cut.
c. The government may use the increase in expenditures on projects with little value, particularly if
it wishes to respond quickly.
d. There is no evidence that tax cuts have been followed by increases in economic growth.
Multiple Choice – Section 03: Should Monetary Policy Be Made by Rule Rather Than by
Discretion?
1. The Federal Open Market Committee meets about
a. every six days.
b. every six weeks.
c. every six months.
d. every sixteen months.
Six Debates over Macroeconomic Policy 8733
2. When the Federal Open Market Committee meets it
a. looks only at the state of economy to determine how to conduct monetary operations in order to
follow the monetary policy rule set by law.
b. looks at the state of the economy and economic forecasts to determine how to conduct monetary
operations in order to follow the monetary policy rule set by law.
c. looks only at the state of the economy to determine the target it will set for the federal funds
rate.
d. looks at the state of the economy and economic forecasts to determine the target it will set for
the federal funds rate.
3. The Federal Open Market Committee
a. by law must focus on maintaining low inflation rather than stabilizing output.
b. by law must focus on stabilizing output rather than maintaining low inflation.
c. by law must follow a mechanical rule that takes into account deviations of unemployment from
its natural rate and deviations of inflation from a target.
d. operates with almost complete discretion over monetary policy.
8734 Six Debates over Macroeconomic Policy
4. A 1977 amendment to the Federal Reserve Act of 1913 says the Fed should “promote” which of
the following goals?
a. only price stability
b. only maximum employment
c. only price stability and maximum employment
d. price stability, maximum employment, and moderate long-term interest rates
5. A 1977 amendment to the Federal Reserve Act of 1913
a. requires the Federal Reserve to place more weight on promoting price stability than on promoting
maximum employment.
b. requires the Federal Reserve to place more weight on promoting maximum employment than on
promoting price stability.
c. requires the Federal Reserve to place equal weight on promoting price stability and maximum
employment.
d. says the Federal Reserve should promote price stability and maximum employment, but does not
specify how the Federal Reserve should weight these goals.
Six Debates over Macroeconomic Policy 8735
6. A 1977 amendment to the Federal Reserve Act of 1913
a. says the Federal Reserve should only promote maximum employment
b. says the Federal Reserve should only promote price stability
c. says the Federal Reserve should promote price stability and maximum employment, but does not
specify how the Federal Reserve should weight these goals.
d. says the Federal Reserve should promote price stability and maximum employment, but specifies
that it place more weight on promoting price stability.
7. The Federal Open Market Committee
a. operates with almost complete discretion over monetary policy.
b. is required to increase the money supply by a given growth rate each year.
c. is required to keep short-term interest rates within a range set by Congress.
d. is required by its charter to change the money supply using a complex formula that concerns the
tradeoff between inflation and unemployment.
8736 Six Debates over Macroeconomic Policy
8. The Federal Open Market Committee
a. must submit its policies to the President and Senate for approval.
b. operates with almost complete discretion over monetary policy.
c. is required to target short-term interest rates in a mechanical way based on an equation that
takes into account both price stability and output fluctuations.
d. is required to set and publicize targets for money supply growth.
9. The political business cycle refers to
a. the fact that about every four years some politician advocates greater government control of the
Fed.
b. the potential for a central bank to increase the money supply and therefore real GDP to help the
incumbent get re-elected.
c. the part of the business cycle caused by the reluctance of politicians to smooth the business
cycle.
d. changes in output created by the monetary rule the Fed must follow.
Six Debates over Macroeconomic Policy 8737
10. If there is a political business cycle and the Federal Reserve supports the incumbent, then we
should expect that prior to elections
a. interest rates and output would rise.
b. interest rates would rise and output would fall.
c. interest rates would fall and output would rise.
d. interest rates and output would fall.
11. If there is a political business cycle and the Federal Reserve supports the incumbent, then we
should expect that prior to elections the Fed would
a. raise interest rates to shift aggregate demand left.
b. raise interest rates to shift aggregate demand right.
c. reduce interest rates to shift aggregate demand left.
d. reduce interest rates to shift aggregate demand right.
12. According to the political business cycle theory, if the Fed wanted to see a President re-elected,
prior to the election it might
a. lower the discount rate and sell bonds.
b. lower the discount rate and buy bonds.
c. raise the discount rate and sell bonds.
d. raise the discount rate and buy bonds.
8738 Six Debates over Macroeconomic Policy
13. According to the political business cycle theory, if the Fed wanted to see a President re-elected,
prior to the election it might
a. buy bonds to raise interest rates.
b. buy bonds to reduce interest rates.
c. sell bonds to raise interest rates.
d. sell bonds to reduce interest rates.
14. Edward Prescott and Finn Kydland won the Nobel Prize in Economics in 2004. One of their
contributions was to argue that if a central bank could convince people to expect zero inflation,
then the Fed would be tempted to raise output by increasing inflation. This possibility is known as
a. inflation targeting.
b. the monetary policy reaction lag.
c. the time inconsistency of policy.
d. the sacrifice ratio dilemma.
15. Which of the following support the idea that monetary policy should be made by a rule?
a. the political business cycle and the time-inconsistency problem
b. the political business cycle but not the time–inconsistency problem
c. the time-inconsistency problem, but not the political business cycle
d. neither the political business cycle nor the time-inconsistency problem
Six Debates over Macroeconomic Policy 8739
16. The time inconsistency of policy implies that
a. what policymakers say they will do is generally what they will do, but people don’t believe them
because of current policy.
b. when people expect that inflation will be low, it is harder for the Fed to increase output by
increasing the money supply.
c. people will believe Fed policy will be more inflationary than the Fed claims.
d. what policymakers say they will do is usually not what they do, but people believe them
anyway.
17. The time inconsistency of policy implies that
a. what policymakers say they will do is generally what they will do, but people don’t believe them
because of current policy.
b. when people expect that inflation will be low, it is easier for the Fed to increase output by
increasing the money supply.
c. people will believe Fed policy will be less inflationary than the Fed claims.
d. what policymakers say they will do is usually not what they do, but people believe them
anyway.
8740 Six Debates over Macroeconomic Policy
18. The time inconsistency of monetary policy means that
a. once people have formed expectations of low inflation based on a promise by the central bank,
the central bank is tempted to raise inflation to lower unemployment.
b. at some times central banks think it is more important to keep unemployment low; at other
times, they think it is more important to keep inflation low.
c. monetary policy is not consistent across time because it is influenced by politics.
d. monetary policy is not consistent across time because policymakers are incompetent.
19. Time inconsistency will cause the
a. short-run Phillips curve to be higher than otherwise.
b. short-run Phillips curve to be lower the otherwise.
c. long-run Phillips curve to be farther to the right than otherwise.
d. long-run Phillips curve to be farther left than otherwise.
20. If a government managed to reduce the time inconsistency problem by mandating that the central
bank target inflation at a low rate, then
a. the long–run Phillips curve would shift right.
b. the long–run Phillips curve would shift left.
c. the short-run Phillips curve would shift up.
d. the short–run Phillips curve would shift down.
Six Debates over Macroeconomic Policy 8741
21. If people in countries that have had persistently high inflation are skeptical about efforts to reduce
inflation, the short– run Phillips curve will remain far to the
a. left, and the sacrifice ratio will be low.
b. left, and the sacrifice ratio will be high.
c. right, and the sacrifice ratio will be low.
d. right, and the sacrifice ratio will be high.
22. If a central bank had to give up its discretion and follow a rule that required it to keep inflation low,
a. the short-run Phillips curve would shift up.
b. the short–run Phillips curve would shift down.
c. the long–run Phillips curve would shift right.
d. the long–run Phillips curve would shift left.
8742 Six Debates over Macroeconomic Policy
23. If people in a country that has had persistently high inflation expect it to remain high and are
skeptical of promises the central bank makes, then the Phillips curve is
a. farther to the left than otherwise. If the central bank tries to reduce inflation unemployment will
rise by more than if people had believed its promises.
b. farther to the left than otherwise. If the central bank tries to reduce inflation unemployment will
rise by less than if people had believed its promises.
c. farther to the right than otherwise. If the central bank tries to reduce inflation unemployment
will rise by more than if people had believed its promises
d. farther to the right than otherwise. If the central bank tries to reduce inflation unemployment
will rise by less than if people had believed its promises..
24. A law that requires the money supply to grow by a fixed percentage each year would eliminate
a. the time inconsistency problem, but not political business cycles.
b. the political business cycle, but not the time inconsistency problem.
c. both the time inconsistency problem and political business cycles.
d. neither the time inconsistency problem nor political business cycles.