The IS Curve and Monetary Policy

Question 1

What are the 5 variables that equal output in the national income identity?

Answer 1

Consumption, investment, government spending, and imports - exports.

Question 2

What is the variable a in the IS curve?

Answer 2

Aggregate demand shock.

Question 3

What is on the vertical axis of the IS curve?

Answer 3

Real interest rate R.

Question 4

What is on the horizontal axis of the IS curve?

Answer 4

Output Y.

Question 5

What happens to output if interest rate increases on the IS curve? Why (intuitively)?

Answer 5

Output decreases - due to higher borrowing costs, lower investment, etc.

Question 6

For a positive aggregate demand shock, what happens to the IS curve?

Answer 6

The curve shifts to the right, increasing output at the same interest rate.

Question 7

People will base consumption on long-run income rather than their current income - what hypothesis is this?

Answer 7

Permanent income hypothesis.

Question 8

Consumption depends on actual versus potential income. True or false?

Answer 8

False - people smooth consumption over their lives.

Question 9

Spending mechanisms like medicare and welfare are examples of _________ ________.

Answer 9

Automatic stabilisers.

Question 10

Two downsides of government spending to reduce shocks:

Answer 10

1. Policy is delayed.
2. Reduced spending or higher taxes will be needed to finance it.

Question 11

The MP curve is just a straight line. True or false?

Answer 11

True.

Question 12

What would cause the MP curve to rise?

Answer 12

Central bank raises interest rates.

Question 13

What is the adaptive expectations assumption for inflation?

Answer 13

Firms assume inflation will be the same as last year.

Question 14

What is the variable o in the Phillips curve?

Answer 14

Price shocks.

Question 15

Would a positive o value shift the Phillips curve up or down?

Answer 15

Up.

Question 16

Which curve shows how short-run output relates to inflation?

Answer 16

Phillips curve.

Question 17

Which curve shows how the real interest rate relates to short-run output?

Answer 17

IS curve.

Question 18

Which curve shows how the nominal interest rate relates to the real interest rate?

Answer 18

MP curve.

Question 19

If the central bank wants to reduce money supply, they will purchase bonds. True or false?

Answer 19

False, they will sell bonds.

Question 20

What is the IS curve formula?

Answer 20

a - b(R - r)

Question 21

What is the IS curve formula with a multiplier?

Answer 21

1/(1-x) * [a - b(R - r)]

Question 22

With a positive multiplier, is the IS curve flatter or steeper?

Answer 22

Flatter.

Question 23

What is on the horizontal axis of the Phillips curve?

Answer 23

Short-run output.

Question 24

What is on the vertical axis of the Phillips curve?

Answer 24

Change in inflation.