Lec14 iC Questions

Question 1

An economy starts in long-run equilibrium with actual GDP equal to potential GDP. The central bank reduces the real interest rate, resulting in:

a) IS Curve shifts right, positive output gap
b) MP curve shifts up, positive output gap
c) MP curve shifts up, negative output gap
d) MP curve shifts down, positive output gap
e) None of the above

Answer 1

d) MP curve shifts down, positive output gap

“Changes in interest rates are all related to the monetary policy curve”

Question 2

An economy is in a recession with actual GDP below potential GDP. Which of the following could eliminate the negative output gap?

a) Increasing interest rates
b) Appreciation of the domestic currency
c) Increasing government purchases
d) Increasing tax rates
e) None of the above

Answer 2

c) Increasing government purchases

“Increasing government purchases would shift the IS curve to the right, and if you shift it far enough, you eliminate the output gap entirely”

Question 3

If total inflation is 6%, expected inflation was 3%, and cost-push inflation is zero, then:

a) There is a negative output gap
b) There is no output gap
c) There is a positive output gap
d) None of the above

Answer 3

c) There is a positive output gap

Total Inflation = Expected + Demand-Pull + Cost-Push
6 = 3 + DP + 0
DP = 3

“If demand-pull inflation is positive, then there must be a positive output gap”

Question 4

Business optimism in the economy increases. In the short-run, the most likely effect on inflation is:

a) Expected inflation rises
b) Expected inflation falls
c) Unexpected inflation rises
d) Unexpected inflation falls
e) None of the above

Answer 4

c) Unexpected inflation rises

“People expect an inflation to be 2%, then optimism increases, then we create an output gap, that inflation was unexpected”

Question 5

Inflation in Canada for 2023 was 2.9%. If inflation expectations for 2024 were 2.0%, and the nominal interest rate was 6.0% on a one-year loan, then the real interest rate on a one-year loan is:

a) 3.1%
b) 4.0%
c) 6.0%
d) None of the above

Answer 5

Real Inflation = Nominal - Expected
RI = 6.0% - 2.0%
RI = 4.0%

b)

Question 6

Inflation rises from 2% to 4%, and nominal interest rates rise from 5% to 7%, while real interest rates hold steady at 3%. What would have caused the rise in inflation?

a) Inflation expectations
b) Demand-pull inflation
c) Cost-push inflation
d) The answer is uncertain

Answer 6

Real Inflation = Nominal - Expected
3% = 5% - Expected (2%)
3% = 7% - Expected (4%)

a) Inflation expectations

Question 7

The economy starts in long-run equilibrium with actual GDP equal to potential GDP. Business optimism falls, and the banking sector risk premium rises. The overall effect on inflation will be:

a) Negative
b) Uncertain - could be positive, negative, or nothing
c) Positive
d) None of the above

Answer 7

a) Negative

“Optimism Falls, IS curve shifts to the left. The banking sector risk premium rises, causes the MP curve to shift up. You will find very negative output gap inflation.”

Question 8

Statistics Canada reports an increase in inflation and no change in either inflation expectations or unemployment. Which of the following is the most likely cause?

a) An increase in consumer confidence
b) A depreciation of the Canadian dollar
c) An increase in government spending
d) An increase in tariffs on international trade
e) None of the above

Answer 8

d) An increase in tariffs on international trade

Question 9

The economy starts in long-run equilibrium (no output gap). The government increases government spending, and the central bank does not respond. This causes a(n):

a) Decrease in inflation, due to lower demand-pull inflation
b) Increase in inflation, due to higher cost-push inflation
c) Increase in inflation, due to higher inflation expectations
d) Increase in inflation, due to higher demand-pull inflation
e) None of the above

Answer 9

d) Increase in inflation, due to higher demand-pull inflation

“Anything that causes a positive output gap causes demand-pull inflation. Government spending is not a financial shock, and is not a cost or supply shock”

Question 10

The Canadian economy starts in long-run equilibrium. If the U.S. economy enters a recession, and the Bank of Canada responds by attempting to prevent any change in unexpected inflation, how would the IS, MP, and PC curves shift?

a) IS shifts right, MP shifts up, PC no change
b) IS shifts left, MP shifts down, PC shifts up
c) IS shifts left, MP shifts up, PC no change
d) IS shifts left, MP shifts down, PC no change
e) None of the above

Answer 10

d) IS shifts left, MP shifts down, PC no change