CHAPTER 9
Quick Check
1. a. False. An increase in taxes (T) will shift the IS curve down as will an increase in risk premium
(x).
b. False. When unemployment exceeds the natural rate then the output gap is negative.
2. a. Inflation will not change since in the medium run equilibrium actual inflation equals
b. The level of actual inflation will be
´π
3. a. Output increases in the short run. Inflation rises beyond expected inflation as the
b. To leave the real policy rate unchanged, the central bank must raise the nominal policy
©2017 Pearson Education, Inc.
114
c. Consider the period t+2 equilibrium under the assumption that
πt+2
e=´
π
. The central
d. The difference between the two assumptions about expected inflation is dramatic. In both
e. Neither scenario seems completely realistic. In part b, the central bank accepts ever
f. If inflation expectations are anchored, then from period t+3, the central bank raises the
4. a. The PC curve will shift up. In period t+1 output remains at the period t level and
b. The period t+2 equilibrium when
πt+2
e=¿
πt+1 and when the central bank leaves the
©2017 Pearson Education, Inc.
115
c. In the situation with anchored expectations of inflation at the value
´π
, in period t+2
d. They have the same output but in part b, inflation accelerates, in part c inflation is
e. Notice that the permanent increase in the price of oil causes the level of potential output
Dig Deeper
5. a. Unemployment rises in a recession so u-u(-1) will be positive. In a recovery
6. a. The IS curve will shift to the left. Output will fall from period to period t+1 as there is
b. As output falls, the economy moves down the PC curve. The change in inflation is
c. If expected inflation depends on past inflation, then the negative change in inflation
d. The goal of the policy was to reduce the deficit. As output falls, tax revenues would fall
Explore Further
©2017 Pearson Education, Inc.
116
7. a. Output is not at potential in 1933. The unemployment rate is still very high. Although
b. The constantly increasing rate of deflation from 1929 to 1932 suggest a spiral of an
c. The actual value of inflation in 1929 was zero. If the expected rate of inflation had
d. Had a substantial fiscal stimulus taken place in 1930 or even earlier, perhaps the level of
8. a. Real interest rates would be: 1929: 7%; 1930 4.4; 1931 5.6; 1932 13.2; 1933 13.4
b. 1930: -.72 ; 1931 -.49 1932: 4.3 ; 1933: +.14. You notice that unemployment and
9. a. There is a weaker deflation spiral. Deflation increases from 1929 to 1932 when output
b. When real interest rates rise in 1931 and 1932 output growth is more negative.
c. It seems strange that the nominal policy rate increased from 1931 to 1932 when the
©2017 Pearson Education, Inc.
117