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Chapter 15
Inflation: Causes and Consequences
 Multiple Choice Questions
1.
At the beginning of the 21st century most economists
(a) urged the Fed to focus on its goal of high employment.
(b) urged central banks to focus their energy on low inflation.
(c) believed the underlying inflation rate in the U.S. was higher than it had been in the late 1970s.
(d) were critical of the performance of Alan Greenspan has Chairman of the Fed.
2.
Nobel laureate Milton Friedman is known for his assertion that,
(a) “Inflation is caused solely by government budget deficits.”
(b) “Inflation is always and everywhere a monetary phenomenon.”
(c) “The evils of inflation are greatly overrated.”
(d) “Inflation is the opium of the masses.”
3.
A 10% inflation rate means that
(a) prices of some important goods and services have increased by 10%.
(b) every price in the economy has increased by 10%.
(c) the money supply has increased by 10%.
(d) the price level has increased by 10%.
4.
Which of the following is NOT a widely used measure of the price level?
(a) The Price Level Indicator
(b) The Producer Price Index
(c) The Consumer Price Index
(d) The GDP Implicit Price Deflator
Between 1939 and 2000 consumer prices rose about
(a) 10%.
(b) 25%.
(c) 50%.
(d) 950%.
5.
6.
About how much would you have needed in 2000 to buy something that cost $0.10 in 1939?
(a) $0.10
(b) $1.00
(c) $10.00
(d) $100.00
7.
In which of the following decades was the rate of inflation the highest?
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(a)
(b)
(c)
(d)
Inflation: Causes and Consequences
439
1930s
1970s
1980s
1990s
8.
Which of the following statements is correct?
(a) Throughout U.S. history prices have fallen in more years than they have risen.
(b) Prices have risen every year in the United States since 1800.
(c) Prices have fallen in the majority of years since 1939.
(d) Prices fell every year in the 1980s.
9.
Which of the following is the correct expression of the equation of exchange?
(a) MY  PV
(b) MP  VY
(c) M/P  VY
(d) MV  PY
10.
According to the equation of exchange, the velocity of money is equal to
(a) M/PY.
(b) PY/M.
(c) PM/Y.
(d) MY/P.
11.
According to the equation of exchange, the percentage change in the nominal money supply (m
_ ) is
equal to
(a) v    y .
(b) v   – y .
(c)   y – v .
(d) v  y – .
12.
According to the equation of exchange, the percentage change in the price level (  ) is equal to
(a) v  m  y .
(b) v  m – y .
(c) m  y – v .
(d) v  y – m .
13.
If during a particular year, the money supply grows 6%, output grows 4%, and velocity grows 2%,
the inflation rate will be
(a) 0%.
(b) 4%.
(c) 8%.
(d) 12%.
14.
If during a particular year, the money supply grows 7%, output grows 2%, and velocity falls 2%, the
inflation rate will be
(a) 3%.
(b) 7%.
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Hubbard • Money, the Financial System, and the Economy, Fifth Edition
(c) 9%.
(d) 11%.
15.
16.
If during a particular year, output grows 5%, velocity declines 2%, and the inflation rate is 1%, then
the money supply must have grown
(a) –6%.
(b) 2%.
(c) 4%.
(d) 8%.
If everything else is held constant, which of the following would NOT lead to short-term inflation?
(a) An increase in the growth rate of aggregate supply
(b) An increase in the nominal money supply
(c) An increase in consumer spending
(d) An increase in government spending
17.
Holding everything else constant, which of the following would cause an increase in short-term
inflation?
(a) A decrease in the nominal money supply
(b) A decrease in net exports
(c) A decrease in consumer spending
(d) A decrease in the growth rate of aggregate supply
18.
All else being equal, a one-time increase in the money supply leads to
(a) inflation.
(b) a one-time increase in the price level.
(c) a one-time shift to the left in the AD curve.
(d) a permanent shift to the right in the SRAS curve.
19.
Which of the following statements is correct concerning the views of new Keynesians and new
classicals concerning aggregate supply?
(a) New classical economists believe the short-run and long-run aggregate supply curves are both
vertical.
(b) New Keynesian economists believe the short-run and long-run aggregate supply curves slope
upward.
(c) Both new Keynesian and new classical economists believe the aggregate supply curve is vertical
in the long run.
(d) Both new Keynesian and new classical economists believe the aggregate supply curve slopes
upward in the long run.
Which of the following statements is correct concerning the views of new Keynesians and new
classicals concerning aggregate supply?
(a) New classical economists believe the short-run and long-run aggregate supply curves are both
vertical.
(b) New Keynesian economists believe the short-run and long-run aggregate supply curves slope
upward.
(c) Both new Keynesian and new classical economists believe the aggregate supply curve slopes
upward in the long run.
(d) Both new Keynesian and new classical economists believe the aggregate supply curve slopes
upward in the short run.
20.
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21.
Which of the following statements is correct concerning the views of new Keynesians and new
classicals concerning the short-run effects of an unexpected increase in aggregate demand?
(a) New classical economists believe that unexpected increases in aggregate demand affect only
prices.
(b) New Keynesian economists believe that unexpected increases in aggregate demand affect only
output.
(c) Both new Keynesian and new classical economists believe that unexpected increases in
aggregate demand affect only output.
(d) Both new Keynesian and new classical economists believe that unexpected increases in
aggregate demand affect both output and prices.
22.
Which of the following statements is correct according to both new classical and new Keynesian
economists?
(a) An unexpected increase in the money supply will increase only prices in the short run, whereas
an unexpected increase in government spending will increase both prices and output.
(b) An unexpected increase in government spending will increase both prices and output in the
short run.
(c) An unexpected increase in government spending will increase only output in the short run.
(d) Unexpected increases in the money supply or in government spending will increase only prices
in the short run.
23.
Which of the following statements is correct?
(a) Both new Keynesian and new classical economists believe money is neutral in the short run.
(b) New Keynesian economists believe money is neutral in the short run, but new classical
economists do not.
(c) Both new Keynesian and new classical economists believe money is neutral in the long run.
(d) New classical economists believe money is neutral in the long run, but new Keynesian
economists do not.
A one-time increase in oil prices will cause a short-run
(a) increase in the price level and in the level of current output.
(b) increase in the price level and a short-run decrease in the level of current output.
(c) decrease in the price level and in the level of current output.
(d) decrease in the price level and a short-run increase in the level of current output.
24.
25.
A supply shock that is not responded to with an expansionary policy will result in
(a) a one-time increase in the price level, but not inflation.
(b) neither a one-time increase in the price level nor inflation.
(c) both a one-time increase in the price level and inflation.
(d) inflation, but not a one-time increase in the price level.
26.
Inflation occurs whenever
(a) there is a one-time increase in the money supply.
(b) there is a one-time increase in government spending.
(c) the growth rate of nominal aggregate demand exceeds the growth rate of aggregate supply over
sustained periods of time.
(d) the growth rate of nominal aggregate supply exceeds the growth rate of aggregate demand over
sustained periods of time.
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Hubbard • Money, the Financial System, and the Economy, Fifth Edition
27.
A one-time cut in taxes
(a) can result in inflation.
(b) can result in a one-time increase in the price level, but cannot result in inflation.
(c) can result in a one-time decrease in the price level, but cannot result in inflation.
(d) will cause a dollar-for-dollar increase in the money supply.
28.
If the money supply is unchanged, expansionary fiscal policy
(a) cannot result in an increase in the price level.
(b) cannot result in an increase in output.
(c) cannot result in prolonged inflation.
(d) results in prolonged inflation provided it was unexpected.
Expansionary fiscal policy will produce inflation only if
(a) it takes the form of a cut in personal income taxes.
(b) it takes the form of a cut in corporate profit taxes.
(c) it takes the form of an increase in government spending.
(d) it is accompanied by a sustained increase in the money supply.
29.
30.
Sustained inflation will be caused by a sustained growth in the nominal money supply at a rate faster
than the growth rate of velocity and the growth rate of output according to
(a) new Keynesian economists but not according to new classical economists.
(b) new classical economists but not according to new Keynesian economists.
(c) both new classical and new Keynesian economists.
(d) neither new classical nor new Keynesian economists.
31.
According to new classical economists, sustained expected increases in the nominal money supply
will lead to
(a) increases in output in the short run and sustained increases in prices in the long run.
(b) sustained increases in prices, with no short-run increases in output.
(c) short-run increases in prices and output, with a stable price level and no increases in output in
the long run.
(d) sustained increases in both prices and output in the long run.
32.
According to new Keynesian economists, sustained expected increases in the nominal money supply
will lead to
(a) increases in output in the short run and sustained increases in prices in the long run.
(b) sustained increases in prices, with no short-run increases in output.
(c) short-run increases in prices and output, with a stable price level and no increases in output in
the long run.
(d) sustained increases in both prices and output in the long run.
33.
Sustained growth in the money supply doesn’t affect real output in the long run but does lead to
inflation according to
(a) new classical economists, but not new Keynesian economists.
(b) both new classical and new Keynesian economists.
(c) new Keynesian economists, but not new classical economists.
(d) neither new classical nor new Keynesian economists.
The reason that the U.S. economy has experienced long-term inflation since World War II is
34.
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443
(a) the high tax rates imposed by the federal government.
(b) the large budget deficits run by the federal government.
(c) the rate of growth of the money supply has been too fast relative to the rates of growth of
velocity and output.
(d) the long-run increases in the prices of oil and other basic commodities.
35.
Long-term inflation is principally
(a) the result of chronic federal budget deficits.
(b) the result of the slowdown in the growth rate of aggregate supply since 1973.
(c) caused by excess wage demands by unionized workers.
(d) a monetary phenomenon.
36.
During the 1980s countries like Argentina and Israel experienced
(a) high average rates of inflation and rapid average rates of growth of the nominal money supply.
(b) low average rates of inflation and rapid average rates of growth of the nominal money supply.
(c) high average rates of inflation and slow average rates of growth of the nominal money supply.
(d) low average rates of inflation and slow average rates of growth of the nominal money supply.
37.
Government budget deficits can be inflationary in the long run only if they
(a) occur as a result of large cuts in the personal income tax rate.
(b) occur as a result of large increases in defense spending.
(c) cause a leftward shift in the SRAS curve.
(d) are accompanied by rapid growth in the monetary base.
38.
Why, since the early 1980s, have Fed policymakers made low inflation a major goal?
(a) Because high inflation rates reduce the tax revenues collected by the federal government
(b) Because they wish to avoid the rapid and sustained price increases that occurred during the
1970s
(c) Because Congress passed a law in 1981 mandating the Fed to reduce the inflation rate to 2%
(d) Because high inflation rates increase the value of the dollar and make U.S. goods less
competitive in foreign markets
Inflation places a tax on real money balances
(a) by increasing the public’s demand for real money balances.
(b) when those balances pay less than the market rate of interest.
(c) because nominal interest payments are deductible on the personal tax, whereas real interest
payments are not.
(d) whenever the actual inflation rate is less than the expected inflation rate.
39.
40.
Shoe leather costs of inflation
(a) increase as the inflation rate rises.
(b) decline as the inflation rate rises.
(c) would be eliminated by the indexing of income tax brackets.
(d) are the same as menu costs.
41.
Inflation generates an excess burden whenever
(a) it is greater than zero.
(b) income tax brackets are not indexed.
(c) the public’s shoe leather costs exceed the government’s revenue gain from the inflation tax.
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Hubbard • Money, the Financial System, and the Economy, Fifth Edition
(d) bracket creep exceeds the public’s shoe leather costs.
42.
Stanley Fischer has estimated that the annual excess burden in the United States of an inflation rate
of 5% is approximately
(a) $30 million.
(b) $30 billion.
(c) $300 billion.
(d) $3 trillion.
43.
Bracket creep
(a) results in a tax on money balances.
(b) would be zero if the same tax rate were applied to all income.
(c) is greater in 2001 than it was in 1971.
(d) invariably leads to an excess burden.
The tax code
(a) adjusts values of inventories for inflation, but does not adjust the value of depreciation
allowances.
(b) adjusts the value of depreciation allowances for inflation, but does not adjust values of
inventories.
(c) adjusts both values of inventories and the value of depreciation allowances for inflation.
(d) adjusts neither the values of inventories nor the value of depreciation allowances for inflation.
44.
45.
The key reason that expected inflation can distort financial decisions is that
(a) lenders pay taxes on nominal rather than real returns.
(b) lenders have an easier time calculating expected inflation than do borrowers.
(c) expected inflation reduces the real value of the national debt.
(d) expected inflation results in substantial menu costs.
46.
If the nominal interest rate on saving is 12% and the expected inflation rate is 6%, what is the
percentage reduction in real interest income resulting from a tax of 25%?
(a) 25%
(b) 50%
(c) 60%
(d) 100%
47.
Menu costs of inflation are costs arising from
(a) the failure to fully index the tax system for inflation.
(b) attempts by households and firms to avoid paying an inflation tax on money balances.
(c) the need for firms to change prices during times of inflation.
(d) high nominal interest rates.
48.
Inflation that is higher than expected redistributes wealth from
(a) employers to employees under nominal wage contracts.
(b) borrowers to lenders.
(c) lenders to borrowers.
(d) the federal government to taxpayers.
Chapter 15
Inflation: Causes and Consequences
49.
Inflation that is lower than expected redistributes wealth from
(a) employers to employees under nominal wage contracts.
(b) borrowers to lenders.
(c) lenders to borrowers.
(d) the federal government to taxpayers.
50.
Economists believe that the most serious costs of inflation arise from
(a) bracket creep.
(b) menu costs.
(c) redistributions of wealth owing to unexpected inflation.
(d) uncertainty about the rate of inflation.
51.
When inflation fluctuates significantly,
(a) the signals provided by relative prices improve.
(b) the signals provided by relative prices are distorted.
(c) the cost of inflation is minimized.
(d) nominal interest rates will be low.
52.
A classic example of hyperinflation occurred
(a) in Japan in the 1970s.
(b) in the United Kingdom in the 1960s.
(c) in the United States in the 1930s.
(d) in Germany in the 1920s.
53.
A hyperinflation is particularly costly to an economy because
(a) the real tax burden imposed on the public increases dramatically.
(b) there is a large redistribution of wealth from borrowers to lenders.
(c) prices no longer indicate value or direct resource allocation.
(d) the demand for real money balances increases significantly.
54.
Despite its costs, governments typically resist eliminating inflation because
(a) doing so would result in lost output and jobs when the economy is near full employment.
(b) the increase in menu costs because of inflation increases the governments’ tax revenues.
(c) as net lenders, governments benefit from inflation.
(d) governments lack the knowledge of how to eliminate inflation.
55.
The Humphrey-Hawkins Act of 1978
(a) committed the federal government to promoting full employment, even if it comes at the
expense of a stable price level.
(b) committed the federal government to promoting a stable price level, even if it comes at the
expense of full employment.
(c) committed the federal government to promoting full employment and a stable price level.
(d) removed the Secretary of the Treasury from the Board of Governors of the Federal Reserve.
56.
Cost-push inflation results from
(a) workers’ pressure for higher wages.
(b) policymakers’ attempts to increase aggregate demand for current output above the fullemployment level.
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Hubbard • Money, the Financial System, and the Economy, Fifth Edition
(c) attempts by financial markets to deal with bracket creep.
(d) attempts by the public to receive higher after-tax returns on their savings.
57.
In the face of workers pushing for higher wages, an accommodating monetary policy will result in
(a) a higher price level and a lower level of current output.
(b) a lower price level and a higher level of current output.
(c) a higher price level and a higher level of current output.
(d) a lower price level and a lower level of current output.
58.
Cost-push inflation
(a) originates in the desire of policymakers to expand employment.
(b) will result in increases in output, unless policymakers adjust aggregate demand in response.
(c) cannot persist in the long run unless ratified by policymakers.
(d) was outlawed by the Humphrey-Hawkins Act of 1978.
59.
Unless ratified by policymakers, cost-push inflation will result in
(a) persistent long-run inflation.
(b) hyperinflation.
(c) output beyond the full-employment level.
(d) a recession.
Demand-pull inflation results from
(a) workers’ pressure for higher wages.
(b) policymakers’ attempts to increase aggregate demand for current output above the fullemployment level.
(c) attempts by financial markets to deal with bracket creep.
(d) attempts by the public to receive higher after-tax returns on their savings.
60.
61.
At the natural rate of unemployment,
(a) the unemployment rate is zero.
(b) only the structurally and the frictionally unemployed are without jobs.
(c) only the frictionally unemployed are without jobs.
(d) the economy is producing at its maximum level of output.
62.
Attempts by policymakers to keep the rate of unemployment below the natural rate of
unemployment for a sustained period of time will result in
(a) demand-pull inflation.
(b) permanently higher levels of output.
(c) a recession.
(d) a shift of the LRAS curve to the left.
63.
If during a three-year period policymakers attempt to keep unemployment below the natural rate of
unemployment, in the new Keynesian view
(a) the LRAS curve will shift to the right.
(b) the LRAS curve will shift to the left.
(c) the total amount of output produced during the period will be smaller than in the new classical
view.
(d) the total amount of output produced during the period will be greater than in the new classical
view.
Chapter 15
64.
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Inflation: Causes and Consequences
447
New Keynesian and new classical economists agree that
(a) policymakers cannot permanently maintain the unemployment rate below the natural rate.
(b) production beyond the full-employment level of output is impossible, even in the short run.
(c) in the long run the inflation rate must be zero.
(d) the LRAS curve slopes up.
During the late 1970s, households, businesses, and policymakers shifted to the opinion that
(a) higher inflation was acceptable provided it resulted in higher employment.
(b) higher inflation was acceptable provided it resulted in higher output.
(c) reducing inflation was necessary even if it resulted in lower levels of employment and output.
(d) a reduction in inflation should take place provided it did not result in disinflation.
66.
Disinflation is
(a) a decline in the price level.
(b) an inflation rate lower than the natural rate of inflation.
(c) a decline in the long-run rate of inflation.
(d) an inflation rate higher than the natural rate of inflation.
67.
New classical economists believe that the best way to reduce inflation is to
(a) do so gradually.
(b) do so all at once.
(c) use wage and price guidelines.
(d) bring on a recession, which gradually reduces cost-push inflation.
68.
Cold turkey disinflation
(a) is very costly in terms of lost output in both the new classical and new Keynesian views.
(b) is virtually costless in terms of lost output in both the new classical and new Keynesian views.
(c) is very costly in terms of lost output in the new classical view, but virtually costless in the new
Keynesian view.
(d) is very costly in terms of lost output in the new Keynesian view, but virtually costless in the
new classical view.
69.
In the new Keynesian view, disinflation is costly primarily because
(a) workers and firms lack rational expectations.
(b) policy announcements are rarely credible.
(c) nominal wages and prices are sticky.
(d) disinflation policy shifts the LRAS curve.
In the new Keynesian view, a disinflation policy
(a) will almost always result in a recession.
(b) will rarely be credible.
(c) should use the cold turkey, rather than the gradual, approach.
(d) shifts the LRAS curve.
70.
71.
A disinflation policy that lacks credibility
(a) results in a leftward shift of the AD curve.
(b) will increase the lost output and jobs that result from the policy.
(c) will work only if the economy is experiencing a hyperinflation.
(d) will have no effect on inflation.
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Hubbard • Money, the Financial System, and the Economy, Fifth Edition
72.
During the 1970s
(a) Japanese disinflation policy was not credible, but that of the United States was credible.
(b) neither Japanese nor U.S. disinflation policies were credible.
(c) both Japanese and U.S. disinflation policies were credible.
(d) U.S. disinflation policy was not credible, but Japanese disinflation policy was credible.
73.
The typical firm will find that its payoff to reducing price increases after the announcement of a
disinflation policy
(a) increases if it believes that the policy will actually be carried out.
(b) decreases if it believes that the policy will actually be carried out.
(c) is independent of whether the policy is actually carried out.
(d) depends on movements in the LRAS curve.
74.
New Keynesian economists question the credibility of cold turkey disinflation in the real world
because
(a) the independence of central banks allows them to disregard public opinion.
(b) households and businesses do not form their expectations rationally.
(c) a reduction in money growth may reduce output and employment substantially in the short run.
(d) central banks tools to bring the inflation rate down even in the long run.
Whom did President Jimmy Carter appoint chair of the Board of Governors of the Fed in order to
convince the public about his anti-inflation resolve?
(a) Alan Greenspan
(b) Milton Friedman
(c) Paul Volcker
(d) Arthur Burns
75.
76.
Under a rules strategy for monetary policy, the Fed would
(a) follow specific and publicly announced guidelines for policy.
(b) adjust monetary policy as it sees fit.
(c) target the growth rate of M1 but not the growth rate of M2.
(d) target the growth rate of M2 but not the growth rate of M1.
77.
A rule specifying a constant rate of growth of M1 during the early 1980s
(a) was adopted in the United States, but not in Japan.
(b) would have resulted in greater inflation than actually occurred.
(c) would have resulted in a more contractionary policy than the one the Fed actually pursued.
(d) was dropped following an acceleration in the inflation rate.
78.
Economists who back the use of rules by the Fed believe that they would result in
(a) a lower government budget deficit.
(b) increased credibility for Fed actions.
(c) the eventual adoption of price controls.
(d) lower growth rates of aggregate supply.
79.
Price controls tend to be ineffective in controlling inflation because they
(a) fail to shift the SRAS curve sufficiently far to the right.
(b) suppress inflation rather than eliminate it.
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449
(c) widen the government’s budget deficit.
(d) reduce the rate of growth of the money supply.
80.
Deflation occurs when
(a) inflation is falling.
(b) inflation does not rise as quickly.
(c) the price level is falling.
(d) inflation domestically is lower than that found in other countries.

Essay Questions
1.
In 1979 most S&Ls had mortgage loans on their books that paid nominal interest rates of less than
10%. The inflation rate for 1979 was greater than 11%. Why weren’t these S&Ls charging mortgage
interest rates greater than the inflation rate?
2.
Evaluate the following assertion: “The oil price shock of 1974 was responsible for the high rates of
inflation the U.S. experienced throughout the remainder of the 1970s.”
3.
If one-time shifts in the SRAS curve do not lead to inflation, why is it sometimes said that a wave of
wage increases during a given year can lead to cost-push inflation?
4.
If Paul Volcker was a “tough” central banker, why was he unable to reduce inflation without the
economy experiencing significant losses in output and employment?