96) How are inflation and the purchasing power of money related?
97) In what ways is the consumer price index flawed?
98) What is a price index? How do the CPI, the PPI, the PCE Index and the GDP deflator differ?
1) Typically, nominal interest rates and anticipated inflation rates
A) move in opposite directions.
B) are not related.
C) move in the same direction.
D) are such that the nominal rate is one-half the anticipated rate.
2) Unanticipated positive inflation will create
A) losses for creditors and gains for debtors.
B) losses for both creditors and debtors.
C) gains for both creditors and debtors.
D) gains for creditors and losses for debtors.
3) Most of the problems caused by inflation are caused by the fact that
A) there are no ways available for people to protect themselves against inflation.
B) anticipated inflation induces people to protect themselves against inflation.
C) inflation causes the purchasing power of the dollar to increase.
D) the inflation is often unanticipated and therefore comes as a surprise to individuals in the
economy.
4) Fully anticipated inflation occurs when
A) the actual inflation rate equals the anticipated inflation rate.
B) the actual inflation rate is less than the anticipated inflation rate.
C) the inflation rate is zero.
D) the anticipated inflation rate and the unanticipated inflation rate are equal.
5) The real rate of interest is the
A) nominal rate of interest minus the anticipated rate of inflation.
B) current rate actually paid by the borrower.
C) difference between the bank’s lending and savings rates.
D) current rate which the government pays on its debt.
6) If the rate of inflation is 6 percent and the real interest rate is 2 percent, the nominal interest
rate should be
A) 2 percent.
B) 4 percent.
C) 8 percent.
D) -2 percent.
7) Under which one of the following situations would you be better off?
A) You have $10,000 in your savings account paying 5 percent per year and unanticipated
inflation is 8 percent per year.
B) You have paid $500 for a $1,000 U.S. savings bond that matures in 10 years and
unanticipated inflation is 10 percent per year.
C) You lend a friend $10,000 at 2 percent to be repaid in one year and unanticipated inflation is 4
percent during the year.
D) You borrowed $10,00 at 2 percent to pay for this year’s college expenses and unanticipated
inflation is 3 percent during the year.
8) Suppose that you borrow $50,000 from the bank to purchase some land and you agree to pay 2
percent interest on the loan. If the loan must be repaid in 12 months and the inflation rate is 4
percent during the year, then
A) you will repay the bank with dollars with more purchasing power than you initially borrowed.
B) you will repay the bank with fewer dollars than the bank initially loaned you.
C) you will repay the bank with dollars with less purchasing power than it initially loaned you.
D) the bank will receive fewer dollars, because of inflation, than it had initially expected to
receive.
9) The real rate of interest is defined as
A) zero.
B) the nominal rate of interest.
C) the nominal rate of interest minus the anticipated inflation rate.
D) the nominal rate of interest plus the anticipated inflation rate.
10) The annual rate of inflation averaged 2 percent during the past decade, but borrowers and
lenders anticipate that the price level will rise at a rate of 3 percent next year. The current
nominal interest rate is 7 percent. The real rate of interest is
A) 10 percent.
B) 9 percent.
C) 5 percent.
D) 4 percent.
11) Assume you borrow funds to buy a new car at 3 percent interest and you think that the
economy-wide rate of inflation over the life of the loan will be 2 percent. If you are correct in
your assumption, your real rate of interest on the car loan will be
A) 1 percent.
B) 2 percent.
C) 3 percent.
D) 5 percent.
12) Who stands to gain as a result of unanticipated inflation?
A) creditors
B) debtors
C) persons living on a fixed income
D) retired individuals
13) During a period of unanticipated inflation, the group that is most likely to benefit is
A) debtors.
B) savers.
C) creditors.
D) retired individuals.
14) When the unanticipated inflation rate is zero
A) creditors gain at the expense of debtors.
B) debtors gain at the expense of creditors.
C) neither creditors not debtors gain or lose.
D) both creditors and debtors lose at the expense of the government.
15) The cost of inflation to society includes
I. The opportunity costs of resources used by people to protect themselves against inflation
II. The costs associated with recalculating prices
A) I only
B) II only
C) Both I and II
D) Neither I nor II
16) Inflation can cause a misallocation of resources because
A) inflation doesn’t proceed evenly which means that people have a difficult time determining
when a price change signals a change in relative prices.
B) firms have to change their price labels at unusual times.
C) the nominal rate of inflation doesn’t equal the real rate of inflation.
D) people are encouraged to borrow too much.
17) An unexpected reduction in inflation would tend to benefit which of the following?
A) creditors
B) debtors
C) creditors and debtors
D) neither creditors nor debtors
18) For most people, the problems of inflation are caused by the fact that
A) the inflation is unanticipated.
B) the inflation is anticipated.
C) the inflation rate causes the purchasing power of money to increase.
D) all prices change so there is no way to protect themselves against the decline in their wealth.
19) Unanticipated inflation occurs when
A) everyone knows perfectly the true rate of inflation.
B) the actual inflation rate differs from the anticipated inflation rate.
C) the inflation rate is zero.
D) there is no change in the purchasing power of money.
20) Suppose the actual inflation rate is less than the anticipated inflation rate. Given this
information, we know with certainty that the real rate of interest
A) is negative.
B) is more than the nominal rate of interest.
C) equals the nominal rate of interest.
D) none of the above (i.e., more information is needed to answer this question).
21) The nominal rate of interest is
A) CPI minus an inflationary premium.
B) PPI minus an inflationary premium.
C) the market rate of interest expressed in today’s dollars.
D) the real rate of interest minus the anticipated rate of inflation.
22) The real rate of interest is
A) the nominal rate of interest divided by the anticipated rate of inflation.
B) negative if the anticipated rate of inflation is zero.
C) the market rate of interest expressed in today’s dollars.
D) the nominal rate of interest minus the anticipated rate of inflation.
23) With respect to the interest rate, the inflationary premium
A) is added to the nominal rate of interest to obtain the real rate of interest.
B) is the interest rate expressed in today’s dollars.
C) covers anticipated depreciation in purchasing power.
D) is derived from the COLA.
24) The price level has been rising 5 percent a year for 10 years and is expected to continue to do
so. The nominal rate of interest is 4 percent. The real rate of interest is
A) 5 percent.
B) 1 percent.
C) 9 percent.
D) -1 percent.
25) The inflation rate has been 7 percent for 10 years, and the nominal interest rate has been 6
percent during this same time period. Suddenly, the public anticipates that the inflation rate will
be 6 percent this coming year. The real rate of interest for the coming year is
A) 0 percent.
B) 2 percent.
C) 4 percent.
D) 13 percent.
26) The nominal rate of interest is
A) the interest rate observed in today’s market.
B) the interest rate observed in the market minus the inflation premium.
C) not influenced by inflation.
D) a value that depends upon the stock market.
27) The real rate of interest is
A) the interest rate observed in the market.
B) the interest rate observed in the market minus the anticipated inflation rate.
C) not influenced by inflation.
D) a value that depends upon the stock market.
28) The real rate of interest equals 3% and the expected rate of inflation equals 2%. The nominal
rate of interest equals
A) 2%.
B) 3%.
C) -1%.
D) 5%.
29) The real rate of interest equals 2%, and the expected rate of inflation equals 2%. The nominal
rate of interest is
A) -2%.
B) 2%.
C) 4%.
D) 0%.
30) Debtors gain and creditors lose when
A) the anticipated rate of inflation is greater than the actual rate of inflation.
B) the anticipated rate of inflation is less than the actual rate of inflation.
C) the anticipated rate of inflation is the same as the unanticipated rate of inflation.
D) the unanticipated rate of inflation is zero.
31) The menu cost of inflation involves
A) the mistakes producers make in adjusting prices.
B) the mistake people make when they do not know the actual rate of inflation.
C) cost-of-living adjustments.
D) the costs associated with changing price lists.
32) Unanticipated positive inflation
A) hurts everyone.
B) hurts creditors.
C) hurts debtors.
D) benefits banks.
33) A COLA is
A) unanticipated positive inflation.
B) unanticipated negative inflation.
C) the cost associated with recalculating prices and printing new price lists when there is
inflation.
D) an automatic increase in wages that takes into account increases in the price level.
34) A clause in a contract that automatically increases wages to account for increases in the price
level is
A) the GDP deflation.
B) the PCE index.
C) a COLA.
D) the real rate of interest.
35) The purpose of COLAs is to protect
A) lenders.
B) borrowers.
C) workers.
D) businesses.
36) Which one of the following is TRUE?
A) The nominal rate of interest is the real rate plus the anticipated rate of inflation.
B) The real rate of interest is the nominal rate plus the anticipated rate of inflation.
C) Increases in anticipated inflation increase the real interest rate.
D) Increases in the CPI increase the real interest rate.
37) The real rate of interest can be defined as the
A) nominal interest rate less the anticipated rate of inflation.
B) anticipated rate of inflation less the nominal interest rate.
C) the market rate of interest expressed in today’s dollars.
D) nominal rate of interest less the unanticipated rate of inflation.
38) Empirical evidence shows that the nominal interest rate typically rises at the same time the
inflation rate increases. What does this suggest?
A) The real rate of interest is zero.
B) Increases in the current inflation rate lead borrowers and lenders to expect that inflation in the
future will be higher than previously thought.
C) Interest rate changes are the main component of the CPI.
D) Interest rate changes are the main component of the GDP deflator.
39) Which one of the following would benefit financially from unanticipated inflation?
A) a borrower whose loan has a fixed nominal interest rate
B) a borrower with an adjustable rate mortgage
C) a bank that has made loans at a fixed nominal interest rate
D) a firm whose workers are covered by a COLA agreement
40) Suppose the rate of inflation unexpectedly decreases from 7% to 4%. Which one of the
following would most likely benefit from this unexpected reduction in the rate of inflation?
A) creditors.
B) a borrower whose loan has a fixed nominal interest rate.
C) debtors.
D) workers who are covered by a COLA agreement.
41) An unexpected increase in the rate of inflation
A) benefits both creditors and debtors.
B) hurts both creditors and debtors.
C) benefits creditors but hurts debtors.
D) hurts creditors but benefits debtors.
42) Unanticipated inflation benefits
A) people or businesses who owe funds.
B) people or businesses who lend funds.
C) people who live on a fixed income.
D) people with CDs (certificates of deposits) in the bank.
43) Who is likely to be helped by unanticipated inflation?
A) lenders
B) borrowers
C) all consumers
D) all producers
44) Why is there a resource cost associated with inflation?
A) because unemployment increases when there is inflation
B) because most workers end up working fewer hours during periods of inflation
C) because consumers, workers, and firms devote resources to protecting themselves from the
financial costs of inflation
D) because the existence of inflation discourages people from placing their savings in interest-
bearing accounts, where it is needed to fund capital investment
45) If a bank advertises 3 percent interest for a checking account and the anticipated rate of
inflation is 3.5 percent
A) the real rate of interest earned on the account is 0.5 percent.
B) the real rate of interest earned on the account is -0.5 percent.
C) the real rate of interest earned on the account is 6.5 percent.
D) the real rate of interest earned on the account is 3.25 percent.
46) How much should a bank charge for a loan, if the anticipated inflation rate is 3 percent, and
the bank wants to earn 3 percent on this $1,000,000 loan?
A) $30,000
B) $10,000
C) 6 percent
D) 0 percent
47) If your income rises at 4 percent and inflation has risen at 3 percent, then the purchasing
power of your income has
A) eroded.
B) stayed the same.
C) fallen, but will increase due to indexing.
D) increased.
48) If you anticipate that the inflation rate is going to rise from 2 percent to 5 percent next year,
you should
A) save your funds at a fixed rate of interest.
B) borrow funds at a fixed rate of interest.
C) keep your funds in your sock drawer.
D) wait to buy a house until next year.