Chapter 21
Output, Inflation, and Monetary Policy
Multiple-Choice Questions
1. Short-run movements in inflation and output are ultimately attributed to changes in:
a. aggregate demand.
b. aggregate supply.
c. foreign policy.
d. aggregate demand and aggregate supply.
2. The Fed hopes to impact short-run inflation and output by altering:
a. the production function.
b. aggregate supply.
c. aggregate demand.
d. fiscal policy.
3. The aggregate demand curve shows the quantity of:
a. nominal output demanded at each level of inflation.
b. real output demanded at each level of inflation.
c. output made available at each level of inflation.
d. real output demanded at each level of real interest rate.
4. Aggregate supply is the quantity of:
a. real output supplied at each level of inflation.
b. nominal output supplied at each level of inflation.
c. real output supplied at each level of real interest rate.
d. output the country wants at each level of inflation.
5. Business cycles are viewed as:
a. movements in the short-run equilibrium.
b. situations where aggregate demand does not equal short-run aggregate supply.
c. inevitable; every economy must experience them.
d. movements in the long-run equilibrium.
6. A characteristic of long-run equilibrium is the economy is producing its potential output. This
is:
a. the maximum level of output the economy could produce at any time.
b. the level of output the economy produces when its resources are used at normal rates.
c. defined as using 80 percent of the economy’s resources at any time.
d. the level of output consistent with an unemployment rate of 7.5%.
7. In the long run the inflation rate equals the level implied by:
a. the rate of money growth.
b. aggregate demand.
c. the exchange rate.
d. fiscal policy.
8. Potential output of the country when viewed over long periods of time:
a. rises in spurts and then starts a downward trend that can last years.
b. is surprisingly constant.
c. always decreases.
d. tends to rise over time.
9. Which of the following would cause an increase in the potential output of a country?
a. An increase in the capital s
toc
k
b. A temporary decrease in exports
c. An increase in the money supply
d. A decrease in the labor force
10. The potential output of a country would increase as a result of each of the following, except:
a. an increase in population.
b. an increase in capital per worker.
c. technological innovation that increases labor productivity.
d. depreciation of the capital stock.
11. Which of the following statements is most accurate?
a. Potential output is determined by current output.
b. When an expansionary gap exists, current output is below potential output.
c. Current output cannot exceed potential output.
d. During a recessionary gap, current output is below potential output.
12. In the long run, current output will:
a. equal potential output.
b. be less than potential output.
c. be above potential output.
d. only equal potential output if unemployment is zero.
13. In the long run, if we ignore changes in velocity, inflation will:
a. be zero.
b. equal the rate of money growth.
c. equal money growth less the growth in potential output.
d. equal money growth plus the growth in potential output.
14. Given the equation of exchange, MV = PY, when central bankers control short-term nominal
interest rates by adjusting the level of reserves in the banking system, their actions are expected
to primarily affect:
a. the rate of growth of V.
b. the value of V.
c. potential Y as opposed to current Y.
d. the rate of growth of M.
15. To an economist, the term “inflation” refers to:
a. any price increases.
b. a continually rising price level.
c. a one-time change in the average price level.
d. increases in prices of important goods like food and energy.
16. If inflation is very high, say 50 or 100 percent a year, monetary policymakers wishing to lower
it will shift their focus to controlling:
a. the long-term interest rate.
b. the short-term interest rate.
c. the exchange rate.
d. money growth.
17. Recent policy statements by the FOMC announce and explain its:
a. targets for money growth with no mention of interest-rate targets.
b. short-term interest-rate and balance-sheet adjustments with no mention of money growth
targets.
c. decisions for long-term interest rates.
d. decisions for money–growth targets but also mentioning short-term interest-rate decisions.
18. The FOMC targets the federal funds rate, but if they are going to alter the course of the
economy they must influence the:
a. real interest rate as well.
b. long-term nominal interest rate as well.
c. real exchange rate as well.
d. nominal exchange rate as well.
19. For central bankers to alter the real interest rate by changing the nominal interest rate, which
of the following must be true?
a. The rate of inflation has to remain constant.
b. Inflation expectations are quite stable.
c. The expected rate of inflation has to change.
d. The change in the expected rate of inflation must equal the change in the nominal interest rate.
20. Empirical evidence suggests that over the last several decades:
a. the nominal and real federal funds rates are related inversely.
b. the nominal and real federal funds rates are highly positively correlated.
c. while the FOMC has had a lot of influence over the nominal federal funds rate, they have
been less successful at changing the real federal funds rate.
d. there is no correlation between the nominal and real federal funds.
21. Which of the following is not a part of aggregate expenditure?
a. Consumption
b. The nominal interest rate
c. Government purchases
d. Net exports
22. Which of the following would not be included in aggregate expenditures?
a. New military equipment purchased by the federal government
b. New computers purchased by a law firm
c. Social security payments made by the government to retirees
d. Tuition payments made by college students
23. Which of the following would not be included in aggregate expenditures?
a. Your purchase of a new car
b. The value of 100 shares of Microsoft stock you purchased
c. The purchase of new textbooks by your local school district
d. The value of blue jeans produced in the U.S. and exported to Japan
24. Of all of the components of aggregate demand, the most interest sensitive is:
a. investment.
b. government purchases.
c. consumption.
d. net exports.
25. Which component of aggregate expenditures is the least sensitive to changes in the real
interest rate?
a. Investment
b. Consumption
c. Net exports
d. Government purchases
26. Consumption can be sensitive to changes in the real interest rate because:
a. higher interest rates can increase the cost of durable goods like automobiles.
b. higher interest rates will result in less saving.
c. lower real interest rates will decrease spending on durable goods and increase spending on
non-durable goods.
d. lower interest rates increase savings.
27. Which of the following statements is most correct?
a. When the real interest rate increases the reward for saving decreases.
b. When the real interest rate decreases current consumption becomes less expensive and the
reward for saving decreases.
c. When the real interest rate decreases the cost of current consumption increases.
d. When the real interest rate increases the level of saving always decreases.
28. Increases in the real interest rate in the U.S. will cause net exports to:
a. decrease, because the dollar depreciates.
b. increase, because the dollar depreciates.
c. decrease, because the dollar appreciates.
d. increase, because the dollar appreciates.
29. A decrease in the real interest rate in the U.S. will cause net exports to:
a. increase because exports will remain constant but imports will
decrea
s
e.
b. decrease because exports will decrease and imports will increase.
c. decrease because exports will increase but imports will increase.
d. increase because exports will increase and imports will decrease.
30. What should be the impact on aggregate expenditures from an increase in the real interest
rate?
a. It should increase
b. It should decrease
c. It should remain constant
d. The impact is indeterminate
31. Which of the following would not shift the aggregate expenditures curve?
a. A change in the real interest rate
b. Changes in consumer or business confidence
c. Fiscal policy changes
d. Changes in net exports that result from exchange rate changes
32. If the level of current output suddenly falls below the potential level of output, central
bankers would:
a. lower the real interest rate.
b. raise the real interest rate.
c. keep the real interest rate constant and focus on only changing the nominal interest rate.
d. attempt to shift the aggregate expenditures curve.
33. If government purchases increase and as a result push current output above potential output,
monetary policymakers are likely to:
a. lower the real interest rate.
b. raise the real interest rate.
c. keep the real interest rate constant and focus on only changing the nominal interest rate.
d. purchase Treasury securities.
34. The relationship between the long-run real interest rate and potential output:
a. is direct.
b. is inverse.
c. is constant since the long-run real interest rate is primarily determined by risk.
d. depends on the actions of central bankers.
35. With the economy at its potential level of output, the federal government undertakes a
large military buildup; all other things equal, the impact on the long-run real interest rate will
be to:
a. increase.
b. decrease.
c. remain constant since output is at its potential level.
d. change at the same rate as inflation.
36. It has been argued that the information technology age has greatly increased productivity
and potential output. If this is true:
a. the long-run real interest rate is also higher as a result.
b. nominal long-run interest rates should have increased.
c. we should have seen lower short-run interest rates than we have seen.
d. the long-run real interest rate is lower as a result.
37. Which of the following statements is correct?
a. The long-run real interest rate varies directly with changes in non-interest sensitive
components of aggregate demand and inversely with potential output.
b. The long-run real interest rate varies inversely with changes in non-interest sensitive
components of aggregate demand and inversely with potential output.
c. The long-run real interest rate varies directly with changes in non-interest sensitive
components of aggregate demand and directly with potential output.
d. The long-run real interest rate varies directly with changes in non-interest sensitive
components of aggregate demand and does not vary with potential output.
38. In the U.S., most of the recessions are associated with:
a. ill-timed fiscal policy.
b. decreasing net exports.
c. decreases in investment.
d. large decreases in consumption.
39. The monetary policy reaction curve:
a. is the guideline the Fed publishes in setting their interest rate target.
b. approximates the behavior of central bankers.
c. has remained fairly constant over the years.
d. is set by Congress and given to the Fed as a guideline to follow.
40. A monetary policy reaction curve requires the central bank to have a(n):
a. money growth target.
b. inflation target.
c. unemployment target.
d. economic growth target.
41. If the axes in the model for the monetary policy reaction curve are the real interest rate
(vertical axis) and the rate of inflation (horizontal axis), then the monetary policy reaction curve
would:
a. have a positive slope.
b. have a negative slope.
c. have a zero slope.
d. be vertical.
42. The point where the central bank’s target inflation rate is consistent with the long-run real
interest rate lies:
a. above the monetary policy reaction curve.
b. below the monetary policy reaction curve.
c. on the monetary policy reaction curve.
d. on the horizontal (inflation) axis.
43. If policymakers are aggressive in keeping current inflation near the target inflation rate then
the monetary policy reaction curve will:
a. be steep.
b. be flat.
c. have an undefined slope.
d. be vertical.
44. If a point lies on the monetary policy reaction curve, and at this point the inflation rate
equals the target rate of inflation, we know that:
a. the real interest rate corresponding to this point is above the long-run real interest rate.
b. the real interest rate corresponding to this point is equal to the long-run real interest rate.
c. the real interest rate corresponding to this point is below the long-run real interest rate.
d. current output is above potential output.
45. The slope of the monetary policy reaction curve is determined by:
a. how strongly the economy reacts to changes in the nominal interest rate.
b. how strongly the inflation rate impacts peoples’ decisions.
c. how aggressively policymakers change interest rates in response to deviations between
current and target inflation rates.
d. people’s expectations for inflation.
46. If policymakers are not aggressive about keeping inflation close to the target rate, the slope
of the monetary policy reaction curve would be:
a. steep.
b. relatively flat.
c. horizontal.
d. negative.
47. If the slope of the monetary policy reaction curve is relatively flat, it means that central
bankers are:
a. very concerned about keeping inflation close to the target rate.
b. not concerned at all about inflation.
c. less concerned about keeping inflation close to its short-run target.
d. not going to let inflation deviate from its target at all.
48. The effect on the monetary policy reaction curve resulting from policymakers decreasing
their inflation target would be:
a. the monetary policy reaction curve shifting to the left.
b. a movement up the existing monetary policy reaction curve.
c. a movement down the existing monetary policy reaction curve.
d. the monetary policy reaction curve shifting to the right.
49. When the monetary policymakers raise the target inflation rate they:
a. raise the current real inflation rate at every level of current inflation.
b. lower the current real interest rate at every level of current inflation.
c. in effect shift the monetary policy reaction curve to the left.
d. in effect move up along the current monetary policy reaction curve.
50. What would be the impact on the monetary policy reaction curve if the Fed were to raise the
target inflation rate?
a. The monetary policy reaction curve shifts to the left
b. A movement up the existing monetary policy reaction curve
c. A movement down the existing monetary policy reaction curve
d. The monetary policy reaction curve shifts to the right
51. The dynamic aggregate demand curve illustrates that the relationship between inflation and
real output is:
a. direct.
b. inverse.
c. independent.
d. undefined.
52. An inflation rate above the target rate will result in:
a. a movement up along the monetary policy reaction curve and a movement up the dynamic
aggregate demand curve.
b. a movement down along the monetary policy reaction curve and a movement down the
dynamic aggregate demand curve.
c. a movement up along the monetary policy reaction curve and a leftward shift of the dynamic
aggregate demand curve.
d. a movement up along the monetary policy reaction curve and a rightward shift of the dynamic
aggregate demand curve.
53. An inflation rate below the target rate will result in:
a. a movement up along the monetary policy reaction curve and a movement down the dynamic
aggregate demand curve.
b. a movement down along the monetary policy reaction curve and a movement down the
dynamic aggregate demand curve.
c. a movement up along the monetary policy reaction curve and a rightward shift of the dynamic
aggregate demand curve.
d. a movement up along the monetary policy reaction curve and a leftward shift of the dynamic
aggregate demand curve.