6) The Lucas critique is an objection to the assumption that
A) inflation is always and everywhere a monetary phenomenon.
B) there is a negative relationship between inflation and unemployment.
C) historical relationships between macroeconomic variables will continue to hold after new
policies are in place.
D) people form expectations rationally.
7) The argument that when policy changes, people’s behavior changes so that historical
relationships between macroeconomic variables will no longer hold is known as
A) the Phillips curve.
B) the policy irrelevance hypothesis.
C) hysteresis.
D) the Lucas critique.
8) The idea that new policies change the economic rules and affect economic behavior, so that no
one can safely assume that historical relationships between variables will hold when policies
change, is known as
A) Okun’s Law.
B) Say’s Law.
C) the equation of exchange.
D) the Lucas critique.
9) The long-run Phillips curve is
A) vertical.
B) horizontal.
C) upward sloping.
D) downward sloping.
10) The fact that the long-run Phillips curve is vertical implies that
A) monetary policy can’t affect unemployment.
B) money is neutral in the long run.
C) there is a natural rate of inflation.
D) money can’t affect inflation in the long run.
11) Starting on a Phillips curve with expected inflation equal to 5% and unemployment at its
natural rate, show what happens to unemployment if the Fed tries to reduce inflation, but has no
credibility. As time passes and people realize that the inflation rate is now lower, what happens
to the short-run Phillips curve?
12) Why did the government use expansionary monetary policies in the late 1970s, and what was
the principal negative macroeconomic effect of these policies?
13) What is the Lucas critique, and why was it so important to macroeconomists in the 1970s?
12.3 The Problem of Unemployment
1) When the economy goes into a recession, there’s an increase in
A) frictional unemployment.
B) structural unemployment.
C) cyclical unemployment.
D) voluntary unemployment.
2) Which of the following forms of unemployment probably imposes the greatest personal costs?
A) frictional unemployment.
B) structural unemployment.
C) cyclical unemployment.
D) voluntary unemployment.
3) According to Okun’s law, if full-employment output is $5000 billion, then each percentage
point of unemployment sustained for one year reduces output by
A) $50 billion.
B) $100 billion.
C) $150 billion.
D) $200 billion.
4) Some economists argue that Okun’s Law overstates the cost of cyclical unemployment
because
A) the cost of retraining workers must be offset against the loss in output that occurs when
workers are unemployed.
B) if efficiency wages prevail, and workers are paid their real wage, already employed workers
will reduce their effort, reducing output.
C) it ignores the fact that leisure increases during a recession.
D) it ignores the loss of government revenue and additional government expenditures that occur
when unemployment rises.
5) The natural rate of unemployment in the United States generally ________ from 1960 to 1980
and ________ from 1980 to 2000.
A) fell; rose
B) fell; fell
C) rose; fell
D) rose; rose
6) One reason for the fall in the natural rate of unemployment from 1980 to 2000 is
A) changes in the demographic composition of the work force.
B) the decline in inflation.
C) increased competition from foreign workers.
D) the depreciation of the dollar relative to foreign currencies.
7) One reason for the rise in the natural rate of unemployment from 1960 to 1980 is
A) changes in the demographic composition of the work force.
B) the decline in inflation.
C) increased competition from foreign workers.
D) the depreciation of the dollar relative to foreign currencies.
8) The bulk of the decline in the natural rate of unemployment from 1980 to 2000 is because of
A) a decline in the inflation rate.
B) a decline in the share of young workers in the labor force.
C) increased competition from foreign workers.
D) the depreciation of the dollar relative to foreign currencies.
9) In years when teenagers become a greater percentage of the labor force,
A) the natural rate of unemployment falls.
B) the natural rate of unemployment rises.
C) the inflation rate rises.
D) the inflation rate falls.
10) A difficulty faced by policymakers who wish to use the unemployment rate as a guide to
whether the economy is weak or strong is that
A) the natural rate of unemployment is hard to measure.
B) the natural rate of unemployment almost never changes.
C) policymakers must use data on output to tell whether the unemployment rate is too high or too
low.
D) the impact of policy on the economy is subject to long and variable lags.
11) Because the natural rate of unemployment is not known precisely, policymakers who use it
as a guide for policy must be
A) less aggressive with policy changes than they would be if they knew the value of the natural
rate.
B) more aggressive with policy changes than they would be if they knew the value of the natural
rate.
C) ready to change policy more quickly.
D) aware of other data.
12) What is the relation between the unemployment rate and the proportion of unemployed
workers who have been unemployed for 15 weeks or longer?
A) Both rise in recessions.
B) Both rise in expansions.
C) The unemployment rises in recessions but the proportion of unemployed workers who have
been unemployed for 15 weeks or longer declines in recessions.
D) The unemployment falls in recessions but the proportion of unemployed workers who have
been unemployed for 15 weeks or longer rises in recessions.
13) Describe the principal costs of unemployment. Are there any benefits to unemployment?
14) If you were president of the United States, what would you do to reduce the natural rate of
unemployment? Propose at least three different methods.
12.4 The Problem of Inflation
1) One cost of a perfectly anticipated inflation is that it
A) transfers wealth from lenders to borrowers.
B) transfers wealth from borrowers to lenders.
C) increases menu costs.
D) damages the role of prices as signals in the economy.
2) The costs in time and effort incurred by people and firms who are trying to minimize their
holdings of cash because of inflation are called
A) menu costs.
B) shoe leather costs.
C) transactions costs.
D) imperfect competition costs.
3) Shoe leather costs are
A) the costs in time and effort incurred by people and firms who are trying to minimize their
holdings of cash because of inflation.
B) the costs of changing prices, such as printing and mailing catalogues.
C) the costs of the redistribution of wealth between lenders and borrowers.
D) the costs associated with the confusion of prices as signals.
4) When actual inflation is greater than expected inflation
A) the natural rate of unemployment rises, according to Phillips-curve analysis.
B) cyclical unemployment rises, according to Phillips-curve analysis.
C) there are transfers from borrowers to lenders.
D) there are transfers from lenders to borrowers.
5) When actual inflation is less than expected inflation
A) the natural rate of unemployment falls, according to Phillips-curve analysis.
B) cyclical unemployment falls, according to Phillips-curve analysis.
C) there are transfers from borrowers to lenders.
D) there are transfers from lenders to borrowers.
6) One cost of an unanticipated inflation is that it
A) transfers wealth from lenders to borrowers.
B) transfers wealth from borrowers to lenders.
C) decreases menu costs.
D) increases the purchasing power of money.
7) A COLA is
A) a center of labor activity.
B) a cost of living adjustment.
C) a contract on long-term assets.
D) a crisis of labor analysis.
8) Hyperinflation occurs when
A) the inflation rate rises.
B) the inflation rate declines.
C) the inflation rate is extremely high.
D) the inflation rate is extremely low.
9) With fixed interest rates, unanticipated deflation hurts ________ because ________.
A) lenders; they get paid back in less valuable dollars
B) lenders; they get paid back in more valuable dollars
C) borrowers; they repay the loan in more valuable dollars
D) borrowers; they repay the loan in less valuable dollars
10) Unanticipated deflation can create unemployment if
A) nominal wages are sticky, causing real wages to rise over time.
B) nominal wages are flexible, causing people’s real incomes to decline.
C) banks refuse to make loans at low nominal interest rates.
D) nominal interest rates remain positive.
11) If nominal interest rates have a lower bound of zero and deflation occurs at 3% (i.e., the
inflation rate equals -3%, then the lowest real interest rate possible is
A) -3%.
B) 0%.
C) 3%.
D) 6%.
12) Many central banks around the world target an inflation rate of about ________, because of
upward bias in measured inflation and to reduce the risk of deflation.
A) -2%.
B) 0%.
C) 2%.
D) 5%.
13) Describe the major costs of inflation, being sure to distinguish between anticipated and
unanticipated inflation.
14) Suppose expected inflation in the economy is 5%. Banks set nominal interest rates so they’ll
earn a 2% expected real return. Employers set nominal wages based on a 2% expected real wage
increase. Suppose the nominal interest rate and nominal wages are determined this way, but
actual inflation turns out to differ from the expected inflation rate. Calculate the actual real
interest rate and the percent increase in the real wage for each of the following actual inflation
rates: a) 2%; b) 5%; c) 10%.
12.5 Fighting Inflation: The Role of Inflation Expectations
1) The reduction of the inflation rate is called
A) deflation.
B) disinflation.
C) unflation.
D) reflation.
2) The costs of disinflation would be low if
A) expected inflation falls as inflation falls.
B) wage and price controls were used.
C) the Phillips curve were nearly horizontal.
D) the Phillips curve adjusted slowly to changes in inflation.
3) A rapid and decisive reduction in the rate of growth of the money supply for the purpose of
disinflation is called
A) a salt water policy.
B) a cold shower policy.
C) gradualism.
D) a cold turkey policy.
4) Keynesians prefer a disinflation policy of
A) cold turkey.
B) stabilization.
C) gradualism.
D) aggregate demand management.
5) Which of the following disinflationary monetary policies would classical economists prefer?
A) A cold turkey approach that is announced and credible.
B) A cold turkey approach that is announced, but not credible.
C) A gradual approach that is announced and credible.
D) A gradual approach that is unannounced.
6) The sacrifice ratio is
A) the amount of output lost when the inflation rate is reduced by one percentage point.
B) the percentage reduction in inflation when output falls one percentage point below potential.
C) the percentage change in employment when output declines by one percentage point.
D) the number of percentage points that the unemployment rate rises when output declines by
one percentage point.
7) The amount of output lost when the inflation rate is reduced by one percentage point is called
A) Okun’s law.
B) the sacrifice ratio.
C) the Solow residual.
D) Planck’s constant.
8) Ball found that the disinflation of the early 1980s in the United States had a sacrifice ratio of
about
A) 0.
B) 1.
C) 2.
D) 3.
9) Ball’s research showed that the sacrifice ratio
A) was the same for all countries.
B) was nearly zero for most countries.
C) was about 10 for all countries except the United States, where it was about 2.
D) varied considerably across countries.
10) Ball found that an important factor affecting the sacrifice ratio is
A) the flexibility of the labor market.
B) the shape of the yield curve.
C) the real interest rate.
D) the tightness of fiscal policy.
11) Countries in which wages adjust slowly to changes in the supply of and demand for labor are
likely to have ________ sacrifice ratio.
A) an infinite
B) a high
C) a low
D) a zero
12) Countries in which wages adjust rapidly to changes in the supply and demand for labor are
likely to have ________ sacrifice ratio.
A) an infinite
B) a high
C) a low
D) a negative
13) Countries in which the government does not regulate the labor market are likely to have
________ sacrifice ratio.
A) an infinite
B) a high
C) a low
D) a negative
14) Ball’s research on disinflation across different countries found that
A) costs of disinflation were smaller for rapid disinflation than for gradual disinflation.
B) costs of disinflation were larger for rapid disinflation than for gradual disinflation.
C) costs of disinflation were about the same for both rapid and gradual disinflation.
D) costs of disinflation were smaller when the central bank had a strong inflation-fighting
reputation.
15) If a rapid disinflation has a lower sacrifice ratio than a slow disinflation, then reducing
inflation is best accomplished by
A) gradualism.
B) increasing money growth.
C) reducing interest rates.
D) a cold-turkey approach.
16) The main determinant of how quickly expected inflation adjusts to changes in monetary
policy is
A) the slope of the Phillips curve.
B) the slope of the short-run aggregate supply curve.
C) the credibility of the central bank.
D) the degree of indexation in the economy.
17) Inflation expectations in the United States generally
A) fell from 1971 to 1976, rose from 1977 to 1985, then fell from 1985 to 1995, and have been
stable since then.
B) fell from 1971 to 1985, then rose from 1985 to 2000, and have been stable since then.
C) rose from 1971 to 1987, then fell from 1987 to 2006.
D) rose from 1971 to 1982, then fell from 1982 to 2000, and have been stable since then.
18) What are the pros and cons of using cold turkey disinflation compared to a policy of
gradualism?
19) How is the sacrifice ratio measured? How big is the sacrifice ratio in the United States? In
other countries? What problems are there in measuring the sacrifice ratio?
20) Consider an economy in long-run equilibrium with an inflation rate (π) of 0.08 per year and a
natural unemployment rate of 0.05. Suppose Okun’s law holds and a one percentage point
increase in the unemployment rate reduces real output by 2% of full-employment output. The
expectations-augmented Phillips curve is given by
π = πe – 2.5 (u – 0.05).
Consider a two-year disinflation. In the first year, π = 0.06 and πe = 0.08. In the second year, π =
0.04 and πe = 0.05.
(a) In the first year, what is the value of the unemployment rate?
(b) In the first year, by what percentage does output fall short of full-employment output?
(c) In the second year, what is the value of the unemployment rate?
(d) In the second year, by what percentage does output fall short of full-employment output?
(e) What is the sacrifice ratio for this disinflation?