WEEK 11

Question 1

Classical model of price level

Answer 1

Real quantity is always at its long run equilibrium

Question 2

Real quantity of money equation

Answer 2

real quantity of money = M/P where M = nominal money supply and P = price level

Question 3

Do inflation and money supply move together?

Answer 3

yes, especially during periods of high inflation

Question 4

Can a government pay for its expenses by printing more money?

Answer 4

Yes but will lead to hyperinflation

Question 5

Seignorage

Answer 5

Revenue generated by a government’s right to print money

Question 6

Inflation tax

Answer 6

Reduction in the real value of money held by the public caused by inflation

Question 7

Seignorage equation

Answer 7

= monthly change x money supply

Question 8

inflation tax equation

Answer 8

inflation rate x money supply

Question 9

real seignorage

Answer 9

rate of growth of money supply x real money supply

Question 10

What do people do to avoid paying the inflation tax?

Answer 10

Reduce their real money holdings which forces the government to increase inflation to capture the same amount of real inflation tax Can lead to vicious circle of shrinking real money supply and rising rate of inflation (leads to hyperinflation and fiscal crisis)

Question 11

What do short run policies that produce a booming economy tend to do?

Answer 11

lead to higher inflation

Question 12

What do short run policies that reduce inflation tend to do?

Answer 12

Depress economy

Question 13

What do fluctuations in long run trend of potential output correspond to?

Answer 13

Fluctuations in the natural rate of unemployment

Question 14

Okun’s law

Answer 14

there is a predictable negative relationship between the output gap and the unemployment rate rise in the output gap of 1% reduces the unemployment rate by 0.5%

Question 15

SR Phillips curve

Answer 15

negative short run relationship between unemployment rate and inflation rate

• when unemployment rate is low, inflation is high
• when unemployment rate is high, inflation is low

Question 16

What is the relationship between the output gap and the unemployment rate?

Answer 16

• When the output gap is positive (inflationary gap) unemployment rate is below the natural rate
• When the output gap is negative (recessionary gap) unemployment rate is greater than the natural rate

Question 17

Effect of positive and negative supply shocks on the SRPC

Answer 17

• 1 - positive supply shock shifts curve down
• 3 - negative supply shock shifts curve up

Question 18

How do changes in the expected rate of inflation affect the Phillips’ curve

Answer 18

• Affects the short run trade off between unemployment and inflation
• SRPC shifts up by the amount of the increase in expected inflation

Question 19

What do attempts to reduce unemployment below natural rate do?

Answer 19

Often only raise prices

Question 20

Long run Phillips curve

Answer 20

relationship between unemployment and inflation after the expectations of inflation have had time to adjust to experience

Question 21

NAIRU

Answer 21

• non-accelerating inflation rate of unemployment
• occurs at LRPC level
• unemployment rate at which inflation does not change over time

Question 22

how to avoid accelerating inflation?

Answer 22

unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation

Question 23

disinflation

Answer 23

process of bringing down inflation that is embedded in expectations

Question 24

natural rate of unemployment

Answer 24

• part of the unemployment rate unaffected by the swings of the business cycle
• aka NAIRU

Question 25

debt deflation

Answer 25

reduction in AD arising from the increase in the real burden of outstanding debt caused by deflation

Question 26

zero bound

Answer 26

interest rate cannot go below 0%

Question 27

liquidity trap

Answer 27

• inability to use monetary policy because nominal IR is too low and cannot fall below the zero bound
• can occur whenever there is a sharp reduction in the demand for loanable funds

Question 28

effect of policies to reduce unemployment on Phillips curve

Answer 28

1. If policy makers reduce unemployment, inflation rises
2. economy will revert back to NAIRU, SRPC shifts upwards based on higher inflation
3. if policy makers attempt to keep unemployment at lower level than NAIRU, inflation continues to rise

Question 30

relationship between AD and PC

Answer 30