Download Fourth Quiz with answers

AEM 1300
Fourth Quiz
July 22, 2016
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Point values for each question are indicated. Total points – 20
Part I (Each Question is worth 1 point)
1. If the federal government is reducing net taxes to stimulate the economy at the same time the
Fed is selling bonds in the open market, the expansionary fiscal policy will be
A) less effective, because the Fed's actions will result in higher interest rates and an increase
in the crowding-out effect.
B) more effective, because the Fed's actions will result in lower interest rates and a reduction
in the crowding-out effect.
C) more effective, because the Fed's actions will result in lower interest rates and an increase
in the crowding-out effect.
D) less effective, because the Fed's actions will result in lower interest rates and an increase
in the crowding-out effect.
E) less effective, because the Fed’s actions will result in higher interest rates and an increase
in the “crowding-in” effect.
2. An increase in the price level of the economy after an increase in oil price is an example of
_____. An increased in the price level of the economy after a tax cut is an example of _____.
A) Demand-pull inflation; Demand-pull inflation
B) Cost-push inflation; Cost-push inflation
C) Cost-push inflation; Demand-pull inflation
D) Demand-pull inflation; Cost-push inflation
LRAS
Price Level
SRAS
A
B
C
AD1
AD2
Aggregate output
3. Refer to the figure above. Originally, the economy was at point C. Suppose now the
aggregate demand shits from AD2 to AD1, and the economy moves to B. If the government
does not do anything and there is no technology change, which of the following is likely to
happen next?
A)
B)
C)
D)
AD shifts back and the economy will go back to point C.
LRAS will shift to the right.
The economy will move to A as wages adjust to changes in price level.
SRAS will shift to the right so that it will achieve the original price level.
4. When the AS curve has only a slight upward slope, in the short-run, a rightward shift of AD
curve will result in:
A) a small increase in aggregate output and small inflation.
B) a large increase in aggregate output and large inflation.
C) a small increase in aggregate output and relatively large inflation.
D) a large increase in aggregate output and relatively small inflation.
5. If the long-run aggregate supply curve is vertical, then the multiplier effect of a change in net
taxes on aggregate output, in the long run,
A) is zero.
B) is one.
C) is infinitely large.
D) depends on the price level.
6. In terms of the Aggregate Supply curve, the “long-run” refers to
A) a period of time in which an increase in the cost of production causes a change in the
natural rate of unemployment.
B) a period of time in which wages can be adjusted to changes in other prices.
C) a period of time in which new technology allows the production possibility frontier to
expand.
D) a period of time in which an expansionary fiscal policy shifts the aggregate demand
curve.
7. Which of the following will break down the negative relationship between the unemployment
rate and the inflation rate as predicted by the conventional short run Phillips Curve?
a) Demand-pull inflation
b) Cost-push inflation
c) The negative relationship between the unemployment rate and the inflation rate never
breaks down
d) None of the above
e) Not enough information to say
8. When economy is in recession, which of the following policies could the Fed’s economists
recommend?
I.
II.
III.
IV.
FOMC (Federal Open Market Committee) should sell securities
The Fed should decrease the supply of the US Dollar
The discount rate should be decreased
The treasury should increase taxes
a)I, II and IV
b)I, II and III
c)I and III
d)III only.
9. Which of the following factors can lead to a decrease in the equilibrium interest rate level?
I.
II.
III.
IV.
V.
VI.
a)
b)
c)
d)
The Fed decreases the required reserve ratio.
The Fed increases the required reserve ratio.
The Fed sells securities in the open market.
The Fed purchases of securities in the open market.
People’s income and wealth decreases.
Price level increases.
I , III, and V.
II, IV and VI.
I, IV and V.
II, IV and V.
10. When an economy is in a liquidity trap
a) interest rates are zero and fiscal policy is very effective
b) interest rates are zero and monetary policy is very effective
c) real interest rates are fixed
d) all of the above
e) none of the above
PART II
1.
Suppose the investment schedule for this economy is very steep (i.e. nearly vertical) Which
policy – monetary or fiscal – would you expect to be more effective and why? (For the full
credit, you need to draw 3 panel diagrams to illustrate your answer.) (3 points)
Monetary policy becomes ineffective if the investment function is step (vertical), because a change
in the interest rate cannot increase or decrease investment. Hence there is no change of output. As
depicted in the following graph, any monetary policy won’t affect investment, and investment
remains at Y0 for any level of interest rate.
Given investment remains at same level, equilibrium of output is the same.
r
MS0
MS1
M0
M1
r
r0
r1
M
I
AE
I
0
AE=C+I0+G
Y
Y0
The fiscal policy is more effective for improving the economy because fiscal policy doesn’t exert its
effect through investment. Therefore, increasing or decreasing government expenditure would
shift AE upward or downward, resulting in change of Y. As shown in the following graph, the
increase of government spending increases equilibrium output.
2. Monetary Policy and Fiscal Policy (4 points)
“Japan Eases Monetary Policy in Surprise Move”
By Wall Street Journal, September 19, 2012
TOKYO—The Bank of Japan announced an aggressive expansion of its monetary-easing program,
acting with surprising speed after its analysis suggested that any economic recovery is at least six
months away amid a global slowdown.
The BOJ's move Wednesday follows similar actions by other major central banks. The Federal
Reserve last week announced another round of quantitative easing, and earlier this month the
European Central Bank established an open-ended program sovereign debt buying program in an
attempt to end the euro crisis.
"The BOJ deemed it necessary to act so that Japan's economy will not be derailed from a track
toward sustainable growth under price stability," Gov. Masaaki Shirakawa said at a news
conference after a two-day meeting of the central bank's policy board. He said that a recovery was
unlikely before the end of the fiscal year next March.
The Bank of Japan has joined two other central banks in easing monetary policy. Are central banks
hinting at more long-term changes? Vincent Cignarella discusses on Markets Hub.
The central banks' actions have raised market concerns that they are engaging in "competitive
easings"—each trying to pump more money into its own economy, despite the potential negative
impact elsewhere. The persistent high value of the yen, for example—a bane of Japanese policy
makers—has been attributed in large part to sharply lower U.S. rates caused by the Fed's
quantitative easing.
The BOJ policy board Wednesday increased the size of its asset-purchase program to ¥80 trillion
($1.01 trillion) from ¥70 trillion, and extended its deadline by six months to the end of 2013. With
interest rates near zero, the central bank's main tool for pumping money into the economy—and
stimulating demand—is buying government bonds and other securities.
a)
b)
Suppose that in the monetary market, the equilibrium interest rate is positive. What is
expected to happen to Japan’s economy after its government implements an expansionary
monetary policy? Explain in words and using 3 panel diagrams of the “money market”,
“investment market” and “aggregate expenditure and real output”.
Suppose now in the monetary market, the equilibrium interest rate is zero. What is
expected to happen to Japan’s economy after its government implements an expansionary
c)
monetary policy? Explain in words and using 3 panel diagrams of “money market”,
“investment market” and “aggregate expenditure and real output”.
Suppose now in the monetary market, the equilibrium interest rate is zero. If you were a
policy maker in Japan and your goal is to increase real output, would you use monetary
policy or fiscal policy? Choose one policy that you think is more effective to increase real
output under these conditions and explain how it is expected to work through 3 panel
diagram as well as aggregate demand and aggregate supply curve.
Answer key.
1.
2.
3.(Expansionary)Fiscal policy. An increase in government expenditure or a tax cut will shift up the
planned aggregate expenditure curve and as a result increases real out put. There will be a clouding-out
effect (money demand goes up -> interest rate goes up -> investment goes down), but overall effect is
positive.
Expansionary money policy would not work here. Since the interest rate is already zero, the Japan’s
government cannot increase investment by lowering the interest rate.
1. Aggregate demand and aggregate supply (3 points)
“Kocherlakota: Plan Suggests Easy Fed Policy For Four Or More Years”
By Wall Street Journal, October 10, 2012
A key U.S. central bank official refined a plan that could keep monetary policy easy for
years to come, in a speech that acknowledged "mixed reactions" to what he has been
proposing.
Speaking in Great Falls, Mont., on Wednesday, Minneapolis Fed President Narayana
Kocherlakota again argued in favor of a policy that would keep central bank policy very easy
until the unemployment rate hit 5.5%, as long as inflation stayed under 2.25%. Under such
a plan, rate hikes "may not take place for four or more years," he said in the text of a
speech prepared for delivery before a local growth.
…………………………….....
Mr. Kocherlakota noted reactions to his plan was all over the map, saying many observers
had misunderstood the case he was trying to make. He argued there's some confusion
regarding the true dynamics surrounding the central bank's official mandate to promote job
growth while keeping prices stable. Mr. Kocherlakota said in his speech as long as central
bankers see "no tension" between the two poles of their mandate, they should keep
monetary policy aggressively easy.
………………………………..
Meeting minutes released last week covering the September FOMC gathering showed
central bankers devoting considerable attention to the possibility of employing a set of
economic variables to greater describe how monetary policy will be conducted. One of the
most public advocates for such a system has been Chicago Fed President Charles
Evans, who has argued monetary policy should stay very easy until unemployment
hits 7% or inflation moves well above the Fed's current target rate of 2% to 3%.
Mr. Evans has argued it's pretty unlikely inflation would go that high with
unemployment over 7%. Mr. Kocherlakota offered a similar defense: "Violations of
price stability are unlikely to occur until the unemployment rate is considerably lower
than its current level of 7.8%." He added, "even though the unemployment rate was at
times below 5%, the medium-term inflation outlook based on material prepared for FOMC
meetings has not risen above 2 1/4% percent in the past 15 years."
…….
Mr. Kocherlakota said the considerable amount of slack in the economy generated by
high unemployment rates means there's little chance inflation will flare any time
soon. "There is no such tension at this time" between the jobs and inflation mandates, and
this lack of tension between its two mandates is likely to continue for some time, he said.
a)
b)
Now the economy has a high unemployment rate. Please use an AD and AS diagram to
illustrate why Mr. Kocherlakota and Mr. Evans do not worry that easy monetary policy will
result in high inflation.
Please explain briefly why the short run aggregate supply curve has a positive slope, and
why the short run aggregate supply curve will eventually turn into a vertical line as output
increases.
a.
Because economy has a high unemployment, we are still now having high capacity to produce.
Hence we are at relatively flat segment of AS curve. As shown in the following graph, given we are at
the flat segment of AS, the easy monetary policy, which shifts AD curve to right from AD0 to AD1,
won’t greatly increase our price level. Therefore, we should now worry about high inflation given the
us has high unemployment.
Price
AS
P1
P0
AD0
L
1
L
0
AD1
Y
b.
the short run aggregate supply curve is positive slope because there is lag between the change
of the price of output and the change of the price of input. The most obvious example is sticky wage
theory. If the output price increases relatively to cost of input, the optimal strategy for the firm is to
produce more output.
However, our resource in the word is limited so that supply curve can not go to unlimited. Starting
from certain point, we can not increase output no matter how high the price is.