4) The supporters of a monetary growth rule believe that active monetary policy
A) stabilizes the economy, decreasing the number of recessions and their severity.
B) destabilizes the economy, increasing the number of recessions and their severity.
C) cannot change the inflation rate.
D) cannot change real GDP.
5) Most of the pressure for a monetary growth rule has disappeared because since 1980,
A) the relationship between movements in the money supply and movements in real GDP and the price
level have become much stronger.
B) the relationship between movements in the money supply and movements in real GDP and the price
level have become much weaker.
C) the relationship between movements in interest rates and movements in real GDP and the price level
have become much stronger.
D) the relationship between movements in interest rates and movements in real GDP and the price level
have become much weaker.
6) Most economists believe that the best monetary policy target is
A) an interest rate.
B) the money supply.
C) total bank reserves.
D) the discount rate.
7) The Federal Reserve cannot target both the money supply and the interest rate because it does not
control
A) bank reserves.
B) money demand.
C) the discount rate.
D) open market operations.
8) If the Federal Reserve targets the money supply, and the money demand curve shifts to the left, then
the Fed
A) cannot maintain the money supply target.
B) can maintain the money supply target, but at a lower interest rate.
C) can maintain the money supply target, but at a higher interest rate.
D) can maintain the money supply target with no change in the interest rate.
9) If the Federal Reserve targets the interest rate and the money demand curve shifts to the left, then the
Fed
A) cannot maintain the interest rate target.
B) can maintain the interest rate target, but at a lower quantity of the money supply.
C) can maintain the interest rate target, but at a higher quantity of the money supply.
D) can maintain the interest rate target with no change in the money supply.
10) The Federal Reserve does not target both the money supply and an interest rate because
A) it would be too confusing to Wall Street and would disrupt the financial markets.
B) it would be too easy for Wall Street to determine what policy the Fed is following and this would
destabilize the economy.
C) it would be illegal according to the Federal Reserve Act.
D) the Fed cannot achieve a target for both the money supply and an interest rate at the same time.
11) The Taylor rule links the Federal Reserve’s target for the
A) money supply to shifts in money demand.
B) money supply to changes in interest rates.
C) federal funds rate to economic variables.
D) federal funds rate to the money supply.
12) Suppose that the Federal Reserve Open Market Committee adheres to the ideas expressed by
________. If the economy moves into a recession, the Fed would recommend that the federal funds
target rate decrease as long as the inflation rate did not rise above the publicly announced goal for
inflation.
A) the gold standard
B) the monetarist school of thought
C) inflation targeting
D) the Taylor Rule
13) Using the Taylor rule, if the current inflation rate equals the target inflation rate and real GDP equals
potential GDP, then the federal funds target rate equals the
A) current discount rate.
B) current inflation rate.
C) real equilibrium federal funds rate.
D) current inflation rate plus the real equilibrium federal funds rate.
14) Using the Taylor rule, if the current inflation rate exceeds the target inflation rate and real GDP
exceeds potential GDP, then the federal funds target rate ________ the sum of the current inflation rate
plus the real equilibrium federal funds rate.
A) will be greater than
B) will be less than
C) will be the same as
D) may be greater than or less than
15) Using the Taylor rule, if the current inflation rate equals the target inflation rate and real GDP is less
than potential GDP, then the federal funds target rate ________ the sum of the current inflation rate plus
the real equilibrium federal funds rate.
A) will be greater than
B) will be less than
C) will be the same as
D) may be greater than or less than
16) Suppose the equilibrium real federal funds rate is 2 percent, the target rate of inflation is 2 percent,
the current inflation rate is 4 percent, and real GDP is 2 percent above potential real GDP. If the weights
for the inflation gap and the output gap are both 1/2, then according to the Taylor rule the federal funds
target rate equals
A) 4 percent.
B) 6 percent.
C) 8 percent.
D) 10 percent.
17) Inflation targeting refers to conducting ________ policy so as to commit the central bank to
achieving a ________.
A) fiscal; publicly announced level of inflation
B) fiscal; zero inflation rate
C) monetary; publicly announced level of inflation
D) monetary; zero inflation rate
18) Which of the following statements about inflation targeting is true?
A) Inflation targeting by the central banks in other countries has not typically lowered inflation.
B) Inflation targeting would not reduce the flexibility of monetary policy to address other policy goals.
C) Inflation targeting would not allow the central bank the flexibility to take action against a severe
recession.
D) Inflation targeting would make it easier for households and firms to form accurate expectations of
future inflation, improving their planning and the efficiency of the economy.
19) In the countries that have adopted inflation targeting, the inflation rate has typically
A) increased.
B) decreased.
C) decreased to zero.
D) not changed.
20) The Fed’s preferred measure of inflation is
A) the index of leading economic indicators
B) the core personal consumption expenditures index
C) the consumer price index
D) the GDP deflator
E) the producer price index
21) The Fed uses a “core” price index, one that excludes food and energy prices to measure inflation. It
does so because
A) food and energy have inelastic demand curves and consumers will buy them regardless of their
price.
B) it wants to avoid the blame for high gasoline prices causing inflation.
C) food and energy prices have wide swings that are not related to the causes of general inflation.
D) food and energy prices do not change all that much during the short run, so are irrelevant to the
calculation of inflation.
22) A monetary growth rule means that
A) the Fed will lower interest rates if it thinks a recession is on the horizon.
B) the Fed will raise interest rates if it thinks the economy is growing faster than potential.
C) the money supply should grow at a constant rate.
D) the money supply should grow in response to economic conditions.
23) In recent years, a monetary growth rule has fallen out of favor because
A) it is believed that active monetary policy destabilizes the economy and makes the business cycle
worse.
B) the growth rate of GDP has been highly unstable.
C) the close relationship between movements in M1 and movements in real GDP has become weaker.
D) the growth rate of M1 has become more stable.
24) The argument advanced by Milton Friedman for adopting a monetary growth rule is that
A) active monetary policy potentially destabilizes the economy.
B) the Fed can control the money supply, but not the level of interest rates.
C) a constant rate of growth in the money supply would eliminate the booms and recessions that make
up the business cycle.
D) the growth rate of M1 has been unstable.
25) The leader of the monetarist school and major proponent of a monetary growth rule was
A) Ben Bernanke.
B) Milton Friedman.
C) Alan Greenspan.
D) Paul Volcker.
26) Why doesn’t the Fed have both a money supply target and an interest rate target?
A) Short-term interest rates do not respond to changes in the money supply, which the Fed can control.
B) The Fed does not control money demand.
C) The Fed cannot offset the impact of changes in cash management by the public or changes in lending
policies of commercial banks on the money supply.
D) Only the level of interest rates matters when we consider rates of growth in real GDP, employment,
and rates of price inflation.
27) The Taylor rule helps explain the relationship between the Fed’s ________ and ________.
A) money supply target; economic conditions
B) money supply target; the federal funds target
C) federal funds target; the monetary growth rule
D) federal funds target; economic conditions
28) The Taylor rule accurately predicted the changes in the federal funds target during the period
A) when Alan Greenspan was the chairman of the Federal Reserve Board.
B) when Paul Volcker was the chairman of the Federal Reserve Board.
C) when Arthur Burns was the chairman of the Federal Reserve Board.
D) when William McChesney Martin was the chairman of the Federal Reserve Board.
29) The Taylor rule predicted a federal funds rate which was ________ that set when Paul Volcker was
chairman of the Fed, and a rate which was ________ that set when Arthur Burns chaired the Fed.
A) greater than; equal to
B) greater than; less than
C) less than; equal to
D) less than; greater than
30) According to the Taylor rule, the Fed should set the target for the federal funds rate equal to the sum
of the equilibrium real federal funds rate, the current inflation rate, one-half times the ________, and
one-half times the ________.
A) interest rate gap; inflation gap
B) interest rate gap; output gap
C) inflation gap; output gap
D) unemployment gap; government-spending gap
31) Using the Taylor rule, if the current inflation rate equals the target inflation rate and real GDP is
greater than potential GDP, then the federal funds target rate ________ the sum of the current inflation
rate plus the real equilibrium federal funds rate.
A) will be greater than
B) will be less than
C) will be the same as
D) may be greater than or less than
32) Suppose the equilibrium real federal funds rate is 5 percent, the target rate of inflation is 3 percent,
the current inflation rate is 5 percent, and real GDP is 4 percent above potential real GDP. If the weights
for the inflation gap and the output gap are both 1/2, then according to the Taylor rule the federal funds
target rate equals
A) 1 percent.
B) 9 percent.
C) 13 percent.
D) 17 percent.
33) Suppose the equilibrium real federal funds rate is 3 percent, the target rate of inflation is 3 percent,
the current inflation rate is 1 percent, and real GDP is 8 percent below potential real GDP. If the weights
for the inflation gap and the output gap are both 1/2, then according to the Taylor rule the federal funds
target rate equals
A) -3 percent.
B) -1 percent.
C) 3.5 percent.
D) 7 percent.
34) Inflation targeting is a framework for carrying out monetary policy whereby
A) the central bank adopts a rigid target for inflation and ignores declines in output.
B) the central bank commits to achieving a publicly announced level of inflation.
C) the central bank commits to achieving a target level of inflation which is never announced publicly.
D) the central bank commits to a monetary growth rule.
35) Which of the following is not an argument against inflation targeting?
A) Inflation targeting reduces the flexibility of the Fed to pursue other policy goals.
B) Inflation targeting assumes that the Fed can accurately forecast future inflation rates.
C) Inflation targeting makes monetary policy ineffective because the targets are publicly announced.
D) Inflation targeting holds the Fed accountable for an inflation goal, but may make it less likely the Fed
will achieve other goals.
36) An advantage of the personal consumption expenditures price index (PCE) over the Consumer Price
Index (CPI) as a measure of inflation is that the PCE
A) includes the prices of more consumer goods and services.
B) includes the prices of consumer goods, but not consumer services.
C) includes the prices of consumer services, but not consumer goods.
D) is a fixed market-basket price index that does not allow the mix of products to change each year.
37) The core personal consumption expenditures price index excludes
A) food and energy prices.
B) food and housing prices.
C) energy and housing prices.
D) housing and health care prices.
38) The consumer price index (CPI), the personal consumption expenditures price index (PCE), and the
core PCE have over the last 15 years
A) moved roughly together with the CPI being the most stable.
B) moved roughly together with the PCE being the most stable.
C) moved roughly together with the core PCE being the most stable.
D) not moved together, with the CPI being the most stable.
39) The relationship between GDP and the money supply has gotten stronger since the 1980s.
40) The Fed has adopted an interest rate target for most of the time since World War II.
41) The Federal Reserve’s performance in the mid-to-late 1980s, 1990s, and early 2000s has received high
marks from economists, even without inflation targeting.
42) The Federal Reserve could target both the money supply and the interest rate at the same time if it
controlled money demand along with money supply.
43) Inflation targeting has been adopted by the central banks of several countries including the
European Central Bank.
44) Inflation targeting has typically been accompanied by lower inflation.
45) An argument in favor of the Federal Reserve adopting inflation targeting is that in the long run, the
Fed can have an impact on inflation but not on real GDP.
46) In the Taylor rule, does the target for the federal funds rate respond differently for a recession
caused by a decrease in aggregate demand and for a recession caused by a decrease in short-run
aggregate supply? Explain whether there is or is not a difference in how the target for the federal funds
rate changes.
47) According to the Taylor rule, does the target for the federal funds rate respond differently for an
increase in inflation caused by an increase in aggregate demand and for an increase in inflation caused
by a decrease in short-run aggregate supply? Explain whether there is or is not a difference in how the
target for the federal funds rate changes.
48) Write out the expression for the Taylor rule. Use the Taylor rule to explain how a decline in real
GDP below potential GDP will affect the Federal Reserve’s target for the federal funds rate.
49) Present two arguments as to why the Fed should adopt inflation targeting as a framework for
monetary policy.
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50) Consider the Taylor rule for the target of the federal funds rate. Suppose the equilibrium real
federal funds rate is 2 percent, the target rate of inflation is 3 percent, the current inflation rate is 3
percent, real GDP equals potential real GDP, and the weights are 1/2 for the inflation gap and the
output gap. Using the Taylor rule, what does the target for the federal funds rate equal? Next, if the
Federal Reserve lowered the target for the inflation rate to 1 percent, how much would the target for the
federal funds rate change?