IS-LM-PS

Question 1

deflationary spiral

Answer 1

because of the zero lower bound constraint, central bank cannot decrease nominal interest. expected inflation is negative so more inflation makes real policy rate increase resulting in lower output and increasing deflation, moving further away from equillibrium

Question 2

what are the other names for natural rate of interest

Answer 2

Wicksellian, Neutral

Question 3

what are the effects of fiscal consolidation in the short run

Answer 3

-not attractive
-shifts IS curve to the left
-lowers output Y - Y’
-inflation decreases below stable rate

Question 4

what are the effects of fiscal consolidation in the long run

Answer 4

-central bank decreases policy rate rn to rn’ SHIFT IN LM CURVE DOWNWARDS
-A’ to A’’ back to equill =A vertical
-Y’ to Yn ie. back to potential output level
-attractive
-inflation back to stable rate
- consumption low investment high

Question 5

conclusions

Answer 5

• shocks can be short/medium
  -effects of policies depend on how fast you think the economy adjusts
  -movement of output around its trend are called output fluctuations (business cycles)
  -economic fluctuations are a result of shocks and the dynamic effect of these shocks are propogation mechanism

Question 6

propogation mechanism

Answer 6

dynamic effect of shocks

Question 7

give three explanations why increase in price of oil has less drastic effects now then in the 70s on CPI and GDP

Answer 7

-inflation more anchored by nominal policy
-workers lower bargaining power
-strong improvements in tech and energy efficiency

Question 8

how do we represent increase in price of oil

Answer 8

the markup goes from m to m’

Question 9

effects of increase in price of oil

Answer 9

increase in markup increases price for firms therefore the real wage rate decreases and the natural rate of unemployment un increases

Question 10

stagflation

Answer 10

if output is below potential and inflation continues to increase this will result in stagflation

Question 11

why would the central bank want expectations to remain anchored

Answer 11

as long as expectations remain anchored the CB won’t have to increase rn beyond the natural rate and go through an economic recession.

Question 12

PC equation

Answer 12

Question 13

output gap

Answer 13

Y-Yn = -L(U-Un)

Question 14

The IS curve shifts up with an increase in G, an increase in
T and an increase in x.

Answer 14

false, the IS curve shifts to the right with an increase in G aand shifts to the right with an increase in T and x.

Question 15

. If (u - un) is greater than zero, then (Y - Yn) is greater
than zero.

Answer 15

false, if U>Un than the output gap is negative

Question 16

c. If (u - un) is equal to zero, the output is at potential.

Answer 16

true

Question 17

If (u - un) is less than zero, the output gap is negative.

Answer 17

true

Question 18

if the output gap is positive, inflation is higher than expected inflation

Answer 18

true

Question 19

Okun’s law says that if output growth increases by one
percentage point, the rate of unemployment drops by one
percentage point

Answer 19

False. For every one-percentage point increase in growth, the unemployment rate drops by .4%

Question 20

At the natural rate of unemployment, inflation is neither
rising nor falling

Answer 20

true, at Un inflation would stabilize

Question 21

In a medium-run equilibrium, the rate of inflation is
stable.

Answer 21

true inflation is unchanging at the medium run

Question 22

. The central bank can always act to keep output equal to
potential output

Answer 22

false, if expected inflation is based on last inflation than the central bank might have to trigger a recession

Question 23

It is easier for the central bank to keep output at potential
output if expectations of inflation are anchored

Answer 23

true, if expecations of inflation are anchored the CB won’t have to increase rn beyond the natural rate and trigger a recession

Question 24

. A large increase in the price of oil increases the natural
rate of unemployment

Answer 24

true