Quiz 2

Question 1

most important function of macroeconomic policy

Answer 1

managing expectations (we want to give people certainty)

Question 2

Expectations of inflation can drive reality…

Answer 2

If workers expect prices to rise they will demand higher wages. If firms expect wages and input prices to increase, they will try to increase the price of their own product

Question 3

one of the central tasks of central banks is to

Answer 3

convince the public that the price level is unlikely to rise very much in the future. In order to do so, central banks must be credible — it is difficult to do

Question 4

Federal Reserve Chairman Paul Volker

Answer 4

to kill inflation in 1970, he pushed the federal funds rate to unprecedented levels (20 percent at its peak), inducing the worst economic downturn since the Great Depression.

Question 5

inflation targeting

Answer 5

In recent years, many central banks have adopted a strategy of inflation targeting. They pick and often announce a specific inflation target and then raise or lower interest rates as necessary.

Question 6

Say’s law

Answer 6

supply creates its own demand

Question 7

what if the public expects bad times ahead? What if expenditure (demand) falls below income (supply)

Answer 7

then the recession gap opens up and economic downward spiral begins

Question 8

Keynesian economics

Answer 8

the government can come to the rescue and close the recessionary gap using monetary and fiscal policy

Question 9

monetary and fiscal policy

Answer 9

Buy things with money that doesn’t exist today. Helps in the short term but in terms of the future we are piling up on debt which someone will eventually have to pay. If the government printed the money–inflation

Question 10

monetary policy

Answer 10

If banks decreases interest rate it incentivise people to borrow more cause the cost is less– saving looks less attractive
Lower interest rate may encourage investment by making new plant and equipment cheaper to finance
problem: so low that people may think its more beneficial to hold on to money then hold on to another asset

Question 11

fiscal policy

Answer 11

Rests on gov spending, taxation, and budget deficits
Keynes- expect bad times, gov can get things moving by spending more than it received in taxes and run a large budget deficit. If gov is spending people may expect better times ahead and also start spending
“income multiplier”

Question 12

change in GDP

Answer 12

= (change in deficit spending by gov.) * income multiplier

Question 13

How do we pay the deficit generated by fiscal policy? What about crowding out?

Answer 13

-We need to produce things first before we consume anything. In order to buy something you need to offer something up in exchange. SO supply creates a demand
-Have to sell something to demand something. How did you get your money? Supply your work for money now you can demand something. Supply is necessary for you to demand.

Question 14

Broken window fallacy

Answer 14

if you break a window, have to pay someone to fix it. Guy that fixes it has money. Go to the store and buy groceries. Generating more production and increasing GDP

Question 15

liquidity trap

Answer 15

low interest rate level at which holding money is more desirable than holding any other asset

Question 16

Expectations affect other macroeconomic variable such as

Answer 16

interest and exchange rates

Question 17

The negative relationship between

Answer 17

interest rates and price of bonds. Expect interest rates to go down, we will buy bonds which makes bond prices go up

Question 18

The effect of trade deficits or monetary policy on

Answer 18

exchange rates. If they expect euros to appreciate they buy euros, if they expect it to depreciate they sell euros

Question 19

“In establishing a new country, one of the first things government officials have to do is define a

Answer 19

unit of account; essentially define money

Question 20

The Continental Congress unanimously resolved in 1785 that

Answer 20

the money unit of the united states can be one dollar

Question 21

gold standard : Self-adjusting mechanism

Answer 21

if prices go up then we import more and that moves gold out of the country which means that the supply of money goes down which decreases prices. This also works in the opposite direction.

Question 22

problem with the gold standard:

Answer 22

Under the gold standard, the value of the dollar depends on the value (scarcity) of gold. When the value of gold went up, prices of everything else went down and vice versa. This led to instability of prices.
-New gold mine, found more gold: prices go up.
-Instability of price if people find more gold

Question 23

The Fed was created in

Answer 23

1914

Question 24

at first banks used what to stabilize the business cycle?

Answer 24

the discount rate

Question 25

in the beginning, the Fed had to keep a gold reserve of at least

Answer 25

40% of the currency it issued and should be able to exchange dollars at the $20.67 per ounce rate.

Question 26

by the early 1930’s

Answer 26

however, many analysts had concluded that the gold standard was exerting too much discipline (!!)

Question 27

timeline and evolution of money:

Answer 27

Every note represents gold, create a fed that decides we have gold equivalent to 40% of bills in circulation, then no just 30% and then in 1970’s 0%

Question 28

Monetarists (following Milton Friedman) suggest…

Answer 28

suggest placing M1 money supply on a controlled upward growth path (say 3 to 5% every year)
M * V = P * Q

Question 29

inflation targets done by

Answer 29

controlling short-term interest rates (the federal funds rate) through open market operations
Feds target was 2% for a long time

Question 30

A way to think about the transition over the twentieth century is that in setting monetary policy, the government gradually shifted from

Answer 30

targeting one price of money (the exchange rate) to targeting another (the overall price level/ inflation rate).