Chapter 14

Question 1

What Accompanies Inflation in Terms of Wages?

Answer 1

Inflation is generally accompanied by growth in wages and other factor prices, causing the AS curve to shift upward.

Question 2

What Are the Two Main Components Influencing Wages?

Answer 2

Output gaps and expectations are the two main components influencing wages.

Question 3

How Do Output Gaps Affect Wages?

Answer 3

Inflationary output gaps tend to cause wages to rise, while recessionary output gaps tend to cause wages to fall, but only slowly.

Question 4

How Do Expectations of Inflation Affect Wages?

Answer 4

Expectations of inflation tend to cause wage increases equal to the expected price-level increases. These expectations can be backward-looking, forward-looking, or a combination of the two.

Question 5

What Happens with Constant Inflation and No Supply Shocks?

Answer 5

Expected inflation will eventually equal actual inflation, with no output-gap effect on inflation.

Question 6

What Conditions Allow Constant Inflation with Real GDP Equal to Y*?

Answer 6

Constant inflation can occur if the AD and AS curves shift upward at the same rate with real GDP equal to Y*.

Question 7

What Are the Initial Effects of a Positive Demand Shock?

Answer 7

A rise in the price level and a rise in real GDP. Without validation, output returns to potential while the price level rises further.

Question 8

What Happens with Monetary Validation of a Positive Demand Shock?

Answer 8

Demand inflation proceeds without reducing the inflationary gap, as the AD curve continues to shift upward.

Question 9

What Are the Initial Effects of a Negative Supply Shock?

Answer 9

A rise in the price level and a fall in real GDP. Without validation, output slowly moves back to potential, and the price level falls to its pre-shock level.

Question 10

What Happens with Monetary Validation of a Negative Supply Shock?

Answer 10

Supply inflation continues despite a persistent recessionary gap, as the AD curve shifts up.

Question 11

What Happens if the Bank of Canada Tries to Keep Real GDP Above Y*?

Answer 11

The actual inflation rate will eventually accelerate.

Question 12

What Causes Sustained Inflation?

Answer 12

Sustained inflation is caused by sustained monetary expansion.

Question 13

What Are the Phases of Reducing Sustained Inflation?

Answer 13

Phase 1: Ending monetary validation and allowing the AS curve to remove any inflationary gap. Phase 2: A recessionary gap develops as expectations of further inflation cause the AS curve to shift upward. Phase 3: The economy returns to potential output, sometimes aided by a one-time monetary expansion.

Question 14

What is the Cost of Disinflation?

Answer 14

The recession created in the process, measured by the sacrifice ratio.

Question 15

How is the Sacrifice Ratio Calculated?

Answer 15

The sacrifice ratio is calculated as the cumulative loss in real GDP (expressed as a percentage of Y*) divided by the reduction in inflation.

Question 16

What are Temporary and Sustained Inflation?

Answer 16

Temporary inflation results from short-term factors, while sustained inflation is maintained by continuous monetary expansion.

Question 17

What is the NAIRU?

Answer 17

The Non-Accelerating Inflation Rate of Unemployment (NAIRU) is the unemployment rate at which inflation does not change over time.

Question 18

What are Forward-Looking and Backward-Looking Expectations?

Answer 18

Forward-looking expectations are based on predictions of future inflation, while backward-looking expectations are based on past inflation rates.

Question 19

What are the Pressures on Inflation?

Answer 19

Expectational, output-gap, and supply-shock pressures all influence inflation.

Question 20

What is Monetary Validation?

Answer 20

Monetary validation is the central bank’s action to sustain an existing rate of inflation by adjusting monetary policy in response to demand and supply shocks.

Question 21

What is the Expectations-Augmented Phillips Curve?

Answer 21

It shows the relationship between inflation and unemployment, taking into account the role of inflation expectations.

Question 22

What is Accelerating Inflation?

Answer 22

Accelerating inflation occurs when the inflation rate increases over time, often due to continuous monetary expansion.

Question 23

What is Disinflation?

Answer 23

Disinflation is the process of reducing the rate of inflation.

Question 24

What is the Sacrifice Ratio?

Answer 24

The sacrifice ratio measures the cost of reducing inflation, calculated as the cumulative loss in real GDP divided by the reduction in inflation.