Chapter 16

Question 1

Disinflation

Answer 1

A reduction in the inflation rate

Question 2

A change in the nominal money supply

Answer 2

leads in the long run to a change in the aggregate price level that leaves the real quantity of money, at its original level

Question 3

Classical model of the price level

Answer 3

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

Question 4

In the long run, money is ___________

Answer 4

neutral

Question 5

The classical model of the price level is a better approximation of reality for economies experiencing _____________

Answer 5

high inflation

SRAS shifts more quickly back to long run

Question 6

The FED __________ the debt by creating money and buying the debt back from the public through open-market purchases of Treasury bills.

Answer 6

monetizes

Question 7

Economists refer to the revenue generated by the government’s right to print money as _______________, an archaic term that goes back to the middle ages

Answer 7

seignorage

Question 8

Inflation tax

Answer 8

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

Question 9

Real seignorage =

Answer 9

(∆M/M) x (M/P)

Rate of growth of the money supply x Real money supply

Question 10

Potential output

Answer 10

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

Question 11

When actual aggregate output is equal to potential output, _____________________________

Answer 11

the actual unemployment rate is equal to the natural rate of unemployment

Question 12

When the output gap is positive (inflationary gap), the unemployment rate is _______

Answer 12

below the natural rate

Question 13

When the output gap is negative (recessionary gap), the unemployment rate is ______________

Answer 13

above the natural rate

Question 14

Fluctuations of aggregate output around the long-run trend of potential output correspond to ___________________

Answer 14

fluctuations of the unemployment rate around the natural rate

Question 15

Okun’s law

Answer 15

The negative relationship between the output gap and cyclical unemployment

Question 16

short-run Phillips curve

Answer 16

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

Question 17

When unemployment rate is low

Answer 17

inflation is high

Question 18

When unemployment rate is high, _______

Answer 18

inflation is low

Question 19

expected inflation rate

Answer 19

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

*second most important factor affecting inflation

Question 20

Expectations about future inflation ___________________

Answer 20

directly affect the present inflation rate

Question 21

An increase in the expected inflation shifts _______________

Answer 21

the short-run Phillips curve upward

Question 22

Stagflation

Answer 22

Combination of above-average unemployment rates coupled with inflatioin rates unprecedented

Question 23

To avoid accelerating inflation over time, __________________________________________

Answer 23

The unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation

Question 24

Nonaccelerating inflation rate of unemployment

“NAIRU”

Answer 24

The unemployment rate at which inflation does not change over time

Question 25

Long-run Phillips curve

Answer 25

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

Question 26

Why is the LRPC vertical?

Answer 26

Any unemployment rate below the NAIRU leads to ever-accelerating inflation Any unemployment rate above the NAIRU leads to decelerating inflation

Question 27

Natural rate of unemployment

Answer 27

The portion of the unemployment rate unaffected by the swings of the business cycle

Question 28

Another definition for NAIRU relationship with natural rate

Answer 28

The level of unemployment the economy needs in order to avoid accelerating inflation is equal to the natural rate of unemployment

Question 29

Disinflation

Answer 29

The process of bringing down inflation that is embedded in expectations

Question 30

Core inflation rate

Answer 30

The annual rate of change in the "core" consumer price index (CPI)

Question 31

Why is there no long-run trade-off between unemployment and inflation?

Answer 31

Once expectations of inflatin adjust, wages will also adjust, returning employment and the unemployment rate to their equilibrium (natural) levels Implies Phillips curve is vertical

Question 32

Why is disinflation so costly?

Answer 32

Aggregate output in the short run must typically fall below potential output

Question 33

How can we reduce costs of disinflation?

Answer 33

Not allowing inflation to increase in the first place If central bank is credible and announces in advance its policy to reduce inflation

Question 34

Deflation

Answer 34

Falling aggregate price level

Question 35

Who loses from deflation?

Answer 35

Borrowers

Question 36

Overall effect of deflation?

Answer 36

Reduces aggregate demand =\> deepening an economic slump may lead to further deflation

Question 37

Debt deflation

Answer 37

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

Question 38

Why does debt deflation occur?

Answer 38

Because borrowers, whose real debt rises as a result of deflation, are likely to cut spending sharply, and lenders, whose real assets are now more valuable, are less likely to increase spending

Question 39

**Zero bound** on nominal interest rate

Answer 39

It cannot go below zero

Question 40

Liquidity trap

Answer 40

When conventional monetary policy (cutting interest rates) is ineffective because nominal interest rates ae up against the zero bound