FinalExam

Question 1

Classical monetary transmission mechanism

Answer 1

Classical economists assumed a direct monetary transmission process: any change in M would be felt directly in P.

Question 2

Easy money, expansionary monetary policy, or quantitative easing

Answer 2

Fed actions designed to increase excess reserves and the money supply to stimulate the economy (expand income and employment).

Question 3

Equation of exchange

Answer 3

The heart of classical monetary theory uses the equation M _ V = P _ Q, where M is the supply of money, V is the velocity of money (the average number of times per year a dollar is spent on goods and services, or the number of times it turns over in a year), P is the price level, and Q is the economy’s output level.

Question 4

Inflation targeting

Answer 4

The central bank sets a target on the inflation rate (usually around 2% per year) and adjusts monetary policy to keep inflation in that range.

Question 5

Keynesian transmission mechanism

Answer 5

An increase in the money supply lowers interest rates, thus increasing investment; expanding aggregate demand; and increasing income, output, and employment. The opposite occurs when the money supply is reduced.

Question 6

Liquidity trap

Answer 6

When interest rates are so low that people believe rates can only rise, they hold on to money rather than investing in bonds and suffer the expected capital loss.

Question 7

Monetarist transmission mechanism

Answer 7

An increase in money will reduce interest rates as portfolios rebalance, leading to a rise in investment or consumption and resulting in an increase in aggregate demand and thus an increase in income, output, or the price level.

Question 8

Monetary rule

Answer 8

Keeps the growth of money stocks such as M1 or M2 on a steady path, following the equation of exchange (or quantity theory), to set a long-run path for the economy that keeps inflation in check.

Question 9

Taylor rule

Answer 9

A rule for the federal funds target that suggests that the target is equal to 2% + current inflation rate + 1/2(inflation gap) + 1/2(output gap). Alternatively, it is equal to 2% plus the current inflation rate plus 1/2 times the difference between the current inflation rate and the Fed’s inflation target rate plus 1/2 times the output gap (current GDP minus potential GDP).

Question 10

Tight money, restrictive, or contractionary monetary policy

Answer 10

Fed actions designed to decrease excess reserves and the money supply to shrink income and employment, usually to fight inflation.

Question 11

Adaptive expectations

Answer 11

Inflationary expectations are formed from a simple extrapolation from past events.

Question 12

Efficiency wage theory

Answer 12

Employers often pay their workers wages above the market-clearing level to improve morale and productivity, reduce turnover, and create a disincentive for employees to shirk their duties.

Question 13

Inflationary expectations

Answer 13

The rate of inflation expected by workers for any given period. Workers do not work for a specific nominal wage but for what those wages will buy (real wages), so their inflationary expectations are an important determinant of what nominal wage they are willing to work for.

Question 14

Jobless recovery

Answer 14

Takes place after a recession, when output begins to rise, but employment growth does not.

Question 15

Natural rate of unemployment

Answer 15

The level of unemployment where price and wage decisions are consistent; a level at which the actual inflation rate is equal to people’s inflationary expectations, and cyclical unemployment is zero.

Question 16

Phillips curve

Answer 16

The original curve posited a negative relationship between wages and unemployment, but later versions related unemployment to inflation rates.

Question 17

Rational expectations

Answer 17

Rational economic agents are assumed to make the best possible use of all publicly available information, then make informed, rational judgments on what the future holds. Any errors in their forecasts will be randomly distributed.

Question 18

Stagflation

Answer 18

Simultaneous occurrence of rising inflation and rising unemployment.

Question 19

Absolute advantage

Answer 19

One country can produce more of a good than another country.

Question 20

Comparative advantage

Answer 20

One country has a lower opportunity cost of producing a good than another country.

Question 21

Dumping

Answer 21

Selling goods abroad at lower prices than in home markets, and often below cost.

Question 22

Infant industry

Answer 22

An industry so underdeveloped that protection is needed for it to become competitive on the world stage or to ensure its survival.

Question 23

Quota

Answer 23

A government-set limit on the quantity of imports into a country.

Question 24

Tariff

Answer 24

A tax on imported products. When a country taxes imported products, it drives a wedge between the product’s domestic price and its price on the world market.

Question 25

Terms of trade

Answer 25

The ratio of the price of exported goods to the price of imported goods (Px/Pm).

Question 26

Capital account

Answer 26

Summarizes the flow of money into and out of domestic and foreign assets, including investments by foreign companies in domestic plants or subsidiaries, and other foreign holdings of U.S. assets, including mutual funds, stock, bonds, and deposits in U.S. banks. Also included are U.S. investors' holdings of foreign financial assets, production facilities, and other assets in foreign countries.

Question 27

Currency appreciation

Answer 27

When the value of a currency rises relative to other currencies.

Question 28

Currency depreciation

Answer 28

When the value of a currency falls relative to other currencies.

Question 29

Current account

Answer 29

Includes payments for imports and exports of goods and services, incomes flowing into and out of the country, and net transfers of money.

Question 30

Exchange rate

Answer 30

The rate at which one currency can be exchanged for another, or just the price of one currency for another.

Question 31

Fixed exchange rate

Answer 31

Each government determines its exchange rate, then uses macroeconomic policy to maintain the rate.

Question 32

Flexible or floating exchange rate

Answer 32

A country's currency exchange rate is determined in international currency exchange markets, given the country's macroeconomic policies.

Question 33

Nominal exchange rate

Answer 33

The rate at which one currency can be exchanged for another.

Question 34

Purchasing power parity

Answer 34

The rate of exchange that allows a specific amount of currency in one country to purchase the same quantity of goods in another country.

Question 35

Real exchange rate

Answer 35

The price of one country's currency for another when the price levels of both countries are taken into account; important when inflation is an issue in one country; it is equal to the nominal exchange rate multiplied by the ratio of the price levels of the two countries.