Chapter 18

Question 1

Increases in the money supply lead to ____________

Answer 1

inflation

Question 2

Thanks to Wesley Mitchell’s work, the _____________ of the business cycles was well advanced by 1930. Bit there was no widely accepted _________ of business cycles

Answer 2

measurement; theory

Question 3

Modern business cycles are largely the result of __________________________

Answer 3

shifts in the aggregate demand curve

Question 4

Two innovations of Keynesian economics

Answer 4

Emphasized the short-run effects of changes in aggregate demand on aggregate output, rather than the long-run determination of the aggregate price level

2. Other factors, especially the “animal spirits” are mainly responsible for business cycles

animal spirits = business confidence

Question 5

Classical view graph

Answer 5

SRAS curve is vertical, so shifts in aggregate demand affect the aggregate price level but not aggregate output

Question 6

The Keynesian View Graph

Answer 6

SRAS curve slopes upward, so shifts in the aggregate demand affect aggregate output as wella s aggregate prices

Question 7

Keynesian economics

Answer 7

Rests on two main tenets:

1. Changes in aggregate demand affect aggregate output, employment and prices
2. Changes in business confidence cause the business cycle

Question 8

Some people consider Keynesian economics a synonym for ________________

Answer 8

left-wing economics

Question 9

Macroeconomic policy activism

Answer 9

The use of monetary and fiscal policy to smooth out the business cycle

Question 10

Monetarism

Answer 10

Asserts that GDP will grow steadily if the money supply grows steadily

Question 11

Discretionary monetary policy

Answer 11

The use of changes in the interest rate or the money supply to stabilize the economy

*Face the same problem of lags as fiscal policy, but to a lesser extent

Question 12

Crowding out

Answer 12

When a government deficit drives up interest rates and leads to reduced investment spending

Question 13

Monetary policy rule

Answer 13

A formula that determines the central bank’s actions

Leaves it relatively little discretion

Question 14

Velocity of money

Answer 14

The ratio of nominal GDP to the money supply

*The measure of the number of times the average dollar bill in the economy turns over per year between buyers and sellers

Question 15

Velocity equation

Answer 15

M x V = P x Y

M = money supply

V = velocity

P = aggregate price level

Y = Real Gdp

Question 16

From 1960 to 1980, the velocity of money was __________, leading monetarists to believe that steady growth in the money supply would lead to a stable economy

Answer 16

stable

Question 17

Natural rate hypothesis

Answer 17

Because inflation is eventually embedded into expectations, to avoid accelerating inflation over time the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate

Question 18

Because the government can’t keep unemployment below the natural rate, its task is not to keep unemployment low but to keep it _________ – to prevent large fluctuations in unemployment in either direction

Answer 18

stable

Question 19

The Friedman-Phelps hypothesis made a strong prediction:

Answer 19

that the apparent trade-off between unemployment and inflation would not survive an extended period of rising prices

Question 20

Political business cycle

Answer 20

Results when politicians use macroeconomic policy to serve political ends

Question 21

New classical macroeconomics

Answer 21

An approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output

Question 22

New classical macroeconomics evolved in two steps:

Answer 22

1. Economists challenged traditional arguments about the slope of the short-run aggregate supply curve based on the concept of rational expectations
2. Economists suggested that changes in productivity cause economic fluctuations, known as real business cycle theory

Question 23

Rationa expectations

Answer 23

The view that individuals and firms make decisions optimally, using all available information

*introduced by John Muth

Question 24

Under rational expectations, government intervention ___________________

Answer 24

fails in the short run and the long run

Question 25

Rational expectatioins model

Answer 25

According to it, expected changes in monetary policy have no effect on unemployment and output and only affect the price level

Question 26

New Keynesian economics

Answer 26

Market imperfections can lead to price stickiness for the economy as a whole

Question 27

Total factor productivity

Question 28

Real business cycle theory

Answer 28

Claims that fluctuations in the rate of growth of total factor productivity cause the business cycle

Question 29

Laffer curve

Answer 29

A hypothetical relationship between rax rates and total rax revenue that slopes upward at low tax rates but turns downard when tax rates are high

Question 30

Great Moderation

Answer 30

The period from 1985 to 2007 when the U.S. economy experienced relatively small fluctuations and low inflation

Question 31

Great Moderation consensus

Answer 31

Combines a belief in monetary policy as the main tool of stabilization with skepticism toward the use of fiscal policy, and an acknowledgement of the policy constraints imposed by the natural rate of unemployment and the political business cycle

Question 32

Now it is generally agreed that monetary policy is ineffective only in the case of ____________

Answer 32

a liquidity trap

Question 33

Is expansionary monetary policy helpful in fighting recessions?

Answer 33

Classical macroeconomics: no

Keynesian macroeconomics: Not very

Monetarism: yes

Great Moderation Consensus: yes, except in special circumstances

Question 34

Is expansionary fiscal policy effective in fighting recessions?

Answer 34

Classical macroeconomics: no

Keynesian macroeconomics: yes

Monetarism: no

Great Moderation Consensus: yes

Question 35

Can monetary and or fiscal policy reduce unemployment in the long run?

Answer 35

Classical macroeconomics: no

Keynesian macroeconomics: yes

Monetarism: no

Great Moderation Consensus: no

Question 36

Should fiscal policy be used in a discretionary way?

Answer 36

Classical macroeconomics: no

Keynesian macroeconomics: yes

Monetarism: no

Great Moderation Consensus: No, except possibly in special circumstances

Question 37

Should monetary policy be used in a discretionary way?

Answer 37

Classical macroeconomics: no

Keynesian macroeconomics: yes

Monetarism: no

Great Moderation Consensus: Still in dispute

Question 38

The role of the budget as an ________________ helps keep the economy on an even keel

Answer 38

automatic stabilizer

Question 39

What has the lead role in economic stabilization?

Answer 39

monetary policy

Question 40

Many economists believe that _______________ is usually counterproductive

Answer 40

discretionary fiscal policy

*the lags in adjusting fiscal policy mean that policies intended to fighta slump end up intensifying a boom

Question 41

Macroeconomists agree on three points:

Answer 41

1. monetary policy should play the main role in stabilization policy
2. The central bank should be independent, insulated from political pressures, in order to avoid a political business cycle
3. Discretionary fiscal policy should be used sparingly, both because of policy lags and because of the risks of a political business cycle

Question 42

Ricardian equivalence

Answer 42

Households and firms would see any rise in government spending as a sign that tax burdens were likely to rise in the future, leading to a fall in private spending that would undo any positive effect

Question 43

Arguments for the fiscal stimulus

Answer 43

1. fiscal expasion necessary since monetary policy could not be used anymore (interest rates were zero)
2. Expansiaory fiscal policy would not crowd out investment spending because it is unlikely in a depressed economy with intereset rates close to zero
3. Discretionary policy would get going faster because it was going to be depressed for an extended period of time

Question 44

Arguments against the fiscal stimulus

Answer 44

1. Ricardian equivalence
2. Spending programs might undermine investors’ faith in the government’s abilty to repay its debts, leading to an increase in long-term interest rates despite loose monetary policy

Question 45

quantitative easing

Answer 45

Buying assets other than short-term government debt, notably long-term debt whose interest rate was still significantly above zero

*idea is to drive down longer-term interest rates, which arguably matter more for private spending than short-term rates