54. Each of the following factors contribute to the slope of the dynamic aggregate demand
curve, except the:
a. strength of the effect of inflation on real balances.
b. current level of technology.
c. extent to which monetary policymakers react to a change in current inflation.
d. size of the response of aggregate expenditures to changes in the interest rate.
55. The fact that central bankers tend to respond to higher rates of inflation by increasing the
real interest rate is:
a. one reason the dynamic aggregate demand curve shifts left.
b. one reason the dynamic aggregate demand curve slopes downward.
c. one reason the dynamic aggregate demand curve shifts right.
d. why the monetary policy reaction curve has a negative slope.
56. One way inflation reduces aggregate demand is by:
a. increasing nominal GDP.
b. increasing velocity.
c. reducing real balances.
d. increasing wealth.
57. The dynamic aggregate demand curve has a negative slope for all of the following reasons
except:
a. the reduction in real wealth caused by inflation.
b. the fact that high rates of inflation are good for the stock market.
c. the redistribution that occurs as inflation has a greater impact on the poor than it does on the
wealthy.
d. higher current inflation leads policymakers to increase the real interest rate, which depresses
various components of aggregate expenditures.
58. A rightward shift in the dynamic aggregate demand curve could result from:
a. a decrease in government purchases.
b. an increase in investment resulting from a lower inflation rate.
c. a rightward shift of the monetary policy reaction curve.
d. a leftward shift of the monetary policy reaction curve.
59. A decrease in taxes would cause:
a. the dynamic aggregate demand curve to shift to the left.
b. a movement down and along the existing dynamic aggregate demand curve.
c. a movement up and along the existing dynamic aggregate demand curve.
d. the dynamic aggregate demand curve to shift to the right.
60. A decrease in the inflation target by the central bank would:
a. have no impact on the positioning of the dynamic aggregate demand curve.
b. cause the dynamic aggregate demand curve to shift to the left.
c. cause the dynamic aggregate demand curve to shift to the right.
d. be reflected by a movement down and along the existing dynamic aggregate demand curve.
61. If monetary policymakers fear a recession resulting from increased pessimism on the part of
business people, and they want to avoid the recession, they would:
a. shift the monetary policy reaction curve to the right.
b. shift the monetary policy reaction curve to the
left.
c
. likely lower their target rate for inflation.
d. encourage fiscal policymakers to act.
62. In the short run, the point on the aggregate demand curve where an economy will end up
depends on:
a. the money supply.
b. the long-run rate of inflation.
c. potential output.
d. the short-run aggregate supply curve.
63. In the short run, the aggregate supply curve is:
a. vertical.
b. horizontal.
c. upward sloping.
d. downward sloping.
64. If most people expect the inflation rate will increase, the:
a. long-run aggregate supply curve would shift right.
b. aggregate demand curve would shift right.
c. short-run aggregate supply curve would shift to the right.
d. short-run aggregate supply curve would shift to the left.
65. If output and inflation are unrelated in the long run, the long-run aggregate supply curve
must be:
a. horizontal.
b. vertical.
c. upward sloping.
d. non-existent.
66. The long-run aggregate supply curve intersects the horizontal axis at the:
a. potential level of output.
b. current level of output.
c. expected rate of inflation.
d. actual rate of inflation.
67. Select the answer which best completes the following statement: “at any point along the
long-run aggregate supply curve…”
a. expected inflation equals current inflation and current output is below potential output. b.
the economy is moving toward its potential output level.
c. current output equals potential output and expected inflation equals current inflation. d.
expected inflation is moving toward current inflation.
68. Which of the following statements is incorrect?
a. The point where the short-run and long-run supply curves intersect corresponds to the
potential level of output.
b. Any point on the short-run aggregate supply curve reflects current inflation equals target
inflation.
c. Inflation and output are unrelated in the long run.
d. In the long run, inflation is determined by monetary policy.
69. The intersection of the aggregate demand curve and the short-run aggregate supply curve
determines:
a. current inflation, but not current output.
b. potential output.
c. current output, but not current inflation.
d. current output and current inflation.
70. The economy is in both a short- and long-run equilibrium if:
a. current inflation equals expected inflation and current output equals potential output.
b. the aggregate demand curve intersects the short-run aggregate supply curve.
c. the long-run aggregate supply curve is at potential output.
d. the short-run aggregate supply curve intersects the long-run aggregate supply curve at
potential output.
71. If the economy is in long-run equilibrium:
a. inflation should be accelerating.
b. current output should be greater than potential output.
c. current inflation should equal expected inflation.
d. current inflation should be less than expected inflation.
72. The self-correcting mechanism to return the economy to potential output from output gaps is
the change in:
a. potential output.
b. aggregate demand.
c. short-run aggregate supply.
d. the real interest rate by the central bank.
73. The conditions for long-run equilibrium include each of the following, except:
a. imports equal exports.
b. current inflation is steady and equals target inflation.
c. current output equals potential output.
d. current inflation equals expected inflation.
74. The debate over the causes of recessions in the U.S. in recent years has included arguments
about:
a. monetary policy, but not higher oil prices.
b. decreases in exports.
c. higher oil prices, but not monetary policy.
d. both monetary policy and higher oil prices.
75. If a recession were the result of monetary policy, we should observe:
a. inflation increasing as output decreases.
b. potential output decreasing.
c. inflation slowing as output falls.
d. a high rate of money growth.
76. Evidence points out that since the mid-1950’s just about every recession was preceded by:
a. low interest rates.
b. rising interest rates.
c. falling interest rates.
d. negative real interest rates.
77. Evidence points out that since the mid-1950’s just about every recession was preceded by
rising interest rates. This suggests that the recessions were:
a. caused in part by the actions of the Federal Reserve.
b. the result of changes in consumer confidence.
c. due to increases in oil prices and other production costs.
d. caused by simultaneous shifts in aggregate demand and aggregate supply.
Short Answer Question
78. What are the determinants of the potential output for an economy?
79. Use the equation of exchange to show that in the long run, inflation must equal money
growth less the growth of potential output.
80. Temporary changes in inflation lead to adjustments in the price level. What
causes permanent increases in inflation and why?
81. If changes in the nominal federal funds rate result in equal changes to the expected rate of
inflation, how effective would it be for the FOMC to target the nominal federal funds
rate?
82. Rank the components of aggregate demand by their sensitivity to changes in the real
interest rate. Start with the most sensitive to the least sensitive.
83. Why would central bankers have to pay attention to forecasts regarding consumer
sentiment and expectations of business owners and managers?
84. What distinguishes the short-run real interest rate from the long-run real interest rate?
85. Why is it necessary to understand fluctuations in investment if we want to understand the
fluctuations in the business cycle?
86. If the economy is producing a level of output that is consistent with the potential output
level, and government purchases increase, describe what happens in terms of the long-run real
interest rate, and why, to keep the economy at its potential output level.
87. Given a central bank’s monetary policy reaction curve, if inflation increases by 1% why
would policymakers likely have to increase the nominal interest rate by more than the increase in
the expected rate of inflation?
88. Discuss what happens to the monetary policy reaction curve if the Fed were to lower their
inflation target and why?
89. Is the monetary policy reaction curve applicable only to central banks that have an explicit
inflation target? Explain.
90. Can central bankers set short-term interest rate targets and still control inflation in the long
run or are these goals mutually impossible? Explain.
91. Explain the impact on the monetary policy reaction curve and the nominal interest rate if
the level of government purchases were to decrease and the central bank does not change its
inflation target?
92. Assuming the free flow of capital across borders, explain why a country that has a fixed
exchange rate cannot have an independent monetary policy reaction curve.
93. Use the monetary policy reaction curve to link a higher inflation rate to lower aggregate
demand.
94. Explain the changes that would cause the dynamic aggregate demand curve to shift.
95. Explain why the short-run aggregate supply curve has a positive slope.
96. How would the discovery of a previously unknown large reserve of oil affect the short-run
aggregate supply curve and why? What other change could have the same effect?
97. Is the actual amount of output that corresponds to the long-run aggregate supply curve
fixed? Explain.
99. What are the conditions for long-run equilibrium?
100. Output and inflation movements can arise from either demand or supply shifts. How can
we tell them apart?
101. Evidence seems to point out that just before recessions interest rates rose. Why would
monetary policymakers choose to cause recessions?
Essay Questions
102. Discuss why many economists maintain that continued deficit spending by government is
likely to “crowd out” (decrease) investment spending in the long run.
103. Former Bank of England Governor Mervyn King, commenting on a speech given by then
Fed Chairman Greenspan, said “any (coherent) monetary policy can be written as an inflation
target plus a response to supply shocks.” What do these comments mean and what insight do
they provide us to the focus of central banks?
104. Economists usually maintain that policy designed to increase aggregate demand cannot
have any long-run real effects. What lies behind this argument?
105. At the conclusion of its meeting on January 27, 2016, the Federal Open Market Committee
released a statement that included the following sentence: “Given the economic outlook, the
Committee decided to maintain the target range for the federal funds rate at ¼ to ½ percent. The
stance of monetary policy remains accommodative, thereby supporting further improvement in
labor market conditions and return to 2 percent inflation.” What is the significance of this
statement?