Chapter 16

Question 1

very high inflation is always associated with:

Answer 1

rapid increases in the money supply

Question 2

classical model of the price level

Answer 2

the real quantity of money is always at its long-run equilibrium level

• analyzed as if both long run and short run aggregate supply curves are vertical
• this is a poor asumption during periods of low inflation (where there is an upward sloping SRAS curve)
• classical model is a good approximation for economies that experience persistantly high inflation

Question 3

in countries with persistantly high inflation:

Answer 3

changes in the money supply are quickly translated into changes in the inflation rate

• classical model is a good approximation (SRAS curve is steep/vertical)

Question 4

Seignorage

Answer 4

the revenue granted by the governments right to print money

• accounts for less than 1% of gov. budget

Question 5

the fed is concerned about:

Answer 5

inflation and unemployment

(not revenue)

Question 6

printing money to cover a budget defecit leads to:

Answer 6

inflation

(increase in aggregate price level)

Question 7

inflation tax

Answer 7

the reduction in the value of money held by the public caused by inflation

Question 8

when inflation is high:

Answer 8

• people will avoid holding money
• buy goods that last over time or assets that hold their value (like gold)

Question 9

potential output

Answer 9

the level of real GDP that the economy would produce once all prices had fully adjusted

-grows steadily over time, reflecting long-run growth

Question 10

acutal aggregate output in the short run

Answer 10

fluctuates around potential output

Question 11

output gap

Answer 11

percentage of difference between the actual level of real GDP and potential output

inflationary = output is more than potential

recessionary - output is less than potential

Question 12

unemployment rate

Answer 12

cyclical + natural unemployment (affected by the business cycle)

Question 13

relationship between the unemployment rate and the output gap:

Answer 13

1. when actual aggregate output is equal to potential output, the actual unemployment rate is equal to the natural rate of unemployment
2. when the output gap is positive (inflationary gap), the unemployment rate is below the natural rate. When the output gap is negative (recessionary gap), the unemployment rate is above the natural rate
   - fluctuations of aggreagte output correspond to fluctuations of the unemployment rate

Question 14

negative output gap is associated with ______ unemployment

Answer 14

high

Question 15

positive output gap is associated with _____ unemployment

Answer 15

low

Question 16

okun’s law

Answer 16

the negative relationship between the output gap ad cyclical unemployment

-rise in the output gap of 1 percentage point reduces the unemployment rate by 1/2 of a percentage point

Question 17

expansionary policies lead to a ____ unemployment rate

Answer 17

lower

Question 18

lower unemployment tends to lead to ____ inflation

Answer 18

higher

Question 19

short-run philllips curve

Answer 19

the negative short-run relationship between the unemployment rate and the inflation rate

-slopes downward

Question 20

supply shocks

Answer 20

shift the short run aggregate supply curve – and also shift the SRPC

• ex: surging oil prices
• change the infaltion rate

Question 21

negative & positive supply shocks effects

Answer 21

• negative supply shock shifts SRPC up as inflation rate increases
• positive supply shock shifts SRPC down as inflation rate decreases

Question 22

expected inflation rate

Answer 22

the rate of inflation that employers and workers expect in the near future

• most important factor, other than unemployment rate, affecting inflation
• shifts the SRPC

Question 23

many economists believe that the relationship between changes in expected inflation and changes in actual inflation is ____

Answer 23

one-to-one

Question 24

a attempt to trade off lower unemployment for higher inflation leads to ______ inflation over time

Answer 24

accelerating

Question 25

nonaccelerating inflation rate of unemployment (NAIRU)

Answer 25

the unemployment rate at which inflation does not change over time

–the natural rate of unemployment

-the level of unemployment an economy needs in order to avoid accelerating inflation

Question 26

long run phillips curve

Answer 26

shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience

• vertical because any unemployment rate below NAIRU leads to ever-accelerating inflation
• shows that there are limits to expansionary policies because unemployment below NAIRU cannot be maintained in the long run
• any unemployment rate above NAIRU leads to decelerating inflation

Question 27

which is harder: bringing inflation down or up?

Answer 27

DOWN

Question 28

disinflation

Answer 28

the process of bringing down inflation that is embedded in expectations

-very costly –> keeps unemployment rate high for an exptended period –>some economists think the cost can be reduced by explicitly stating determination to reduce inflation

Question 29

deflation

Answer 29

falling aggregate price level

• common during WWII
• under deflation, lenders gain and borrowers lose (bc value of dollar is worth more in the future)
• Fisher claims that overall deflation reduces aggregate demand, deepening an economic slump

Question 30

debt deflation

Answer 30

the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation

-significant in great depression

Question 31

zero bound

Answer 31

bound on the nominal interest rate – it cannot go below zero

-limits the effectiveness of monetary policy

Question 32

liquidity trap

Answer 32

occurs when conventional monetary policy is ineffective because nominal interest rates are up against the zero bound

-can occur whenever there is a sharp reduction in demand for loanable funds (happened during great depression)