Unemployment, Inflation And Output

Question 1

Define menu costs

Answer 1

Inflation forces firms to change prices more frequently

Question 2

What are shoe leather costs?

Answer 2

The time and effort devoted to beating inflation

Question 3

What are some costs of inflation?

Answer 3

Less liquid assets
Shoe leather costs
Menu costs
Inefficient allocation of resources
Difficult investment/saving decisions 
Hyperinflation can wipe out generation of savings

Question 4

Describe the wage-price spiral:

Answer 4

Low unemployment leads to higher nominal wage, so firms increase prices, so workers ask for higher wage, so firms increase prices

Question 5

The race between prices and wages results in steady wage and price ______

Answer 5

Inflation

Question 6

The natural rate of unemployment is….

Answer 6

The unemployment rate such that the actual inflation rate is equal to the expected inflation rate

Question 7

What does NAIRU stand for?

Answer 7

The non-accelerating-inflation-rate of unemployment

The rate of unemployment required to keep the inflation rate constant

Question 8

Why has the natural unemployment rate increased in Europe?

Answer 8

Labour market rigidities:
Unemployment insurance
Employment protection
Minimum wages
Bargaining rules

Question 9

What is wage indexation?

Answer 9

Automatically increases wages in line with inflation - has great effects when inflation is high or more variable

Question 10

What is inflation?

Answer 10

The rate at which the price level increases

Question 11

What is disinflation?

Answer 11

Decrease in inflation

Question 12

How can disinflation be obtained?

Answer 12

Only at the cost of higher unemployment

Question 13

What is the sacrifice ratio?

Answer 13

The number of point-years of excess unemployment needed to achieve disinflation of 1%

Question 14

What is the Lucas critique?

Answer 14

It states that it is unrealistic to assume that wage setters would not consider changes in policy when forming their expectations

Question 15

What are emphasised nominal to digitise?

Answer 15

Many prices and wages are not readjusted when there is a change in policy

Question 16

What rigidities can make disinflation policy change challenging?

Answer 16

Fixed nominal contracts and staggering of wage decisions

Question 17

What 3 conclusions did Laurence Ball reach when estimating sacrifice ratios for 65 disinflation episodes across 19 countries?

Answer 17

1) disinflations lead to a period of higher unemployment
2) faster disinflations are associated with smaller sacrifice ratios
3) sacrifice ratios are smaller in countries that have shorter wage contracts

Question 18

Can the nominal interest rate ever be negative?

Answer 18

No because no one would hold bonds since money would be more appealing: it pays at least a zero nominal interest rate and can be used for transactions

Question 19

Can the real interest rate be negative?

Answer 19

Yes if expected inflation exceeds the nominal interest rate. The value of money is decreasing because of inflation. You would still want bonds over cash because the real interest rates (which pay nominal interest) will exceed the real interest rate on money (which does not pay nominal interest) by the nominal interest rate.

Question 20

What are the effects of a negative real interest rate on borrowing and lending?

Answer 20

Borrowing becomes very attractive and leads to a large demand for investment