ECON10262 - ECON20262 CHAPTER 8: Inflation Completed A

ECON10262 - ECON20262 CHAPTER 8: Inflation MULTIPLE CHOICE 1. The quote “Inflation is always and everywhere a monetary phenomenon” is attributed to: a. Karl Marx d. Alan Greenspan b. Thomas Sargent e. David Ricardo ...

ECON10262 - ECON20262 CHAPTER 8: Inflation MULTIPLE CHOICE 1. The quote “Inflation is always and everywhere a monetary phenomenon” is attributed to: a. Karl Marx d. Alan Greenspan b. Thomas Sargent e. David Ricardo c. Milton Friedman ANS: C DIF: Easy REF: 8.1 TOP: I. MSC: Remembering 2. The quote “Inflation is always and everywhere a fiscal phenomenon” is attributed to: a. Adam Smith d. Alan Greenspan b. Thomas Sargent e. David Ricardo c. Karl Marx ANS: B DIF: Easy REF: 8.1 TOP: I. MSC: Remembering 3. Inflation is calculated as: a. the overall price level d. the difference in the price level b. the rate of change of the price level e. the percent change in output c. the percent change in the price level ANS: C DIF: Easy REF: 8.1 TOP: I. MSC: Remembering 4. If Pt is the price level in time t, inflation is calculated as: a. 1/Pt d. b. e. c. ANS: E DIF: Medium REF: 8.1 TOP: I. MSC: Remembering 5. When discussing inflation, we generally speak of it in terms of: a. the percent change in the consumer price index b. the percent change in the GDP deflator c. the level of the consumer price index d. one over the consumer price index e. the change in the producer price index ANS: A DIF: Easy REF: 8.1 TOP: I. MSC: Understanding 6. What contributed to Reagan’s defeat of Carter in the 1980 presidential election? a. double-digit inflation b. the low rate of unemployment c. the takeover of the U.S. embassy in Tehran, Iran d. Billy Carter’s beere. Margaret Thatcher ANS: A DIF: Medium REF: 8.1 TOP: I. MSC: Understanding 7. In 1979, President Carter appointed ________ as chairman of the Board of Governors of the Federal Reserve to battle ________. a. Greenspan; inflation d. Bernanke; unemployment b. Volcker; the Soviet Union e. Powell; Ayatollah Khomeini c. Volcker; inflation ANS: C DIF: Easy REF: 8.1 TOP: I. MSC: Understanding 8. In 1979, in the face of rising competition in the fast food hamburger market, McDonald’s reduced the price of its cheeseburger to $0.43. If the CPI in 1979 was 37.2 and the CPI in 2005 was 100, what is the price of a 1979 cheeseburger in 2005 dollars? a. $0.77 d. $0.43 b. $7.36 e. $0.14 c. $1.16 ANS: C DIF: Medium REF: 8.1 TOP: I.A. MSC: Analyzing 9. In 2007, the movie Transformers generated about $27.8 million on its opening day. In 1995, Batman Forever generated $20 million on its opening day. If the CPI in 2005 was 100, the CPI in 1995 was 78.0, and the CPI in 2007 was 106.2, ________ is the larger single-day grossing movie, with about ________ million in revenues in 2005 dollars. a. Transformers; $27.8 d. Transformers; $35.6 b. Batman Forever; $35.6 e. Batman Forever; $27.8 c. Transformers; $26.2 ANS: C DIF: Difficult REF: 8.1 TOP: I.A. MSC: Evaluating 10. Today, the Wendy’s Junior Cheeseburger Deluxe is on the “Right Price Right Size” menu and is priced at $1.19. If the CPI in 1979 was 37.2 and the CPI in 2012 was 117.6, what is the price of a 2012 cheeseburger in 1979 dollars? a. $2.66 d. $0.38 b. $1.07 e. $3.76 c. $1.01 ANS: D DIF: Medium REF: 8.1 TOP: I.A. MSC: Analyzing 11. Sometimes when discussing inflation, we use a measure of inflation that excludes ________ from its calculation because these prices tend to be volatile. a. commodity and energy prices d. food and housing prices b. food and energy prices e. energy and housing prices c. housing prices ANS: B DIF: Easy REF: 8.1 TOP: I.A. MSC: Understanding 12. In the United States, money is backed by: a. oil d. no physical commodityb. gold e. None of these answers are correct. c. silver ANS: D DIF: Easy REF: 8.2 TOP: II. MSC: Understanding 13. Money that has no intrinsic value except as money is called ________ money. a. bonded d. intrinsic b. commodity e. None of these answers are correct. c. fiat ANS: C DIF: Easy REF: 8.2 TOP: II. MSC: Understanding 14. Silver, gold, and chocolate are examples of: a. fiat money d. government money b. commodity money e. None of these answers are correct. c. backed money ANS: B DIF: Easy REF: 8.2 TOP: II. MSC: Evaluating 15. A country on the silver standard uses: a. coins d. commodity money b. fiat money e. None of these answers are correct. c. bond money ANS: D DIF: Easy REF: 8.2 TOP: II. MSC: Understanding 16. Fiat money has value because: a. it is backed by gold d. it is backed by silver b. people believe it has value e. None of these answers are correct. c. it has intrinsic value ANS: B DIF: Easy REF: 8.2 TOP: II. MSC: Understanding 17. Fiat money has value because: a. people believe it has value d. it has intrinsic value b. it is backed by silver e. it is a commodity c. it is backed by gold ANS: A DIF: Easy REF: 8.2 TOP: II. MSC: Understanding 18. Liquidity is a measure of: a. the monetary base b. how many coins are in circulation c. how quickly coins can be melted down d. how quickly an asset can be converted to currency e. the amount of reserves ANS: D DIF: Easy REF: 8.2 TOP: II.A. MSC: Understanding19. The measure of money that includes demand deposits and currency only is called: a. M0 d. M1 b. MZ e. MB c. M2 ANS: D DIF: Easy REF: 8.2 TOP: II.A. MSC: Understanding 20. M2 includes M1 and: a. large time deposits d. long-term bonds b. overnight repurchase agreements e. gold reserves c. saving accounts ANS: C DIF: Easy REF: 8.2 TOP: II.A. MSC: Understanding 21. The monetary base consists of: a. reserves and currency b. M1 plus M2 c. only M1 d. gold reserves plus currency e. a country’s holdings of foreign and domestic currencies ANS: A DIF: Easy REF: 8.2 TOP: II.A. MSC: Understanding 22. In dollar amounts, which of the following is the largest? a. MB d. currency b. M2 e. demand deposits c. M1 ANS: B DIF: Easy REF: 8.2 TOP: II.A. MSC: Understanding 23. Alternative forms of money include: a. frequent flier miles d. PayPal b. gift cards e. All of these answers are correct. c. debit cards ANS: E DIF: Easy REF: 8.2 TOP: II.A.1. MSC: Evaluating 24. The velocity of money is: a. how quickly money can be printed b. how quickly individuals spend their income c. the average number of times a dollar is used in a transaction per year d. how many times individuals are paid per year e. None of these answers are correct. ANS: C DIF: Easy REF: 8.2 TOP: II.B. MSC: Remembering 25. In the quantity equation, the value is: a. real GDP d. the velocity of money b. nominal GDP e. real money c. aggregate expenditureANS: B DIF: Easy REF: 8.2 TOP: II.B. MSC: Understanding 26. The velocity of money can be calculated from the quantity equation with: a. PtYt d. PtYt/Mt b. PtYt Mt e. Mt c. Mt /PtYt ANS: D DIF: Medium REF: 8.2 TOP: II.B. MSC: Analyzing 27. Using the quantity equation, if, Mt = $1,000, Pt = 1.1, and Yt = 100,000, then the velocity of money is: a. 100,000 d. 9.09 b. 0.09 e. 0.11 c. 110 ANS: C DIF: Medium REF: 8.2 TOP: II.B. MSC: Analyzing 28. Using the quantity equation, if Mt = $1,000, Pt = 1.1, and Vt = 11, then real GDP is: a. $100,000 d. $909.19 b. $0.01 e. $826.45 c. $100 ANS: C DIF: Medium REF: 8.2 TOP: II.B. MSC: Analyzing 29. The quantity theory states that the nominal GDP is equal to: a. the real GDP b. the number of dollars in circulation c. the velocity of money d. the effective amount of money used in purchases e. velocity times real GDP ANS: D DIF: Medium REF: 8.2 TOP: II.B. MSC: Remembering 30. According to the classical dichotomy, in the long run there is: a. accelerating economic growth b. perfect connectivity between the nominal and real sides of the economy c. complete separation of the nominal and real sides of the economy d. no growth after the economy reaches the steady state e. zero inflation ANS: C DIF: Medium REF: 8.2 TOP: II.C. MSC: Understanding 31. Which of the following has NO effect on long-run economic growth? a. a store of gold d. investment b. money e. population c. productivity ANS: B DIF: Easy REF: 8.2 TOP: II.C. MSC: Understanding32. In the quantity theory of money, the: a. price level is exogenous b. real GDP, velocity, and money supply are endogenous c. real GDP and money supply are endogenous d. real GDP, velocity, and money supply are exogenous e. real GDP is endogenous ANS: D DIF: Medium REF: 8.2 TOP: II.D. MSC: Understanding 33. In the simple quantity theory of money, the supply of money is: a. exogenous b. a policy variable c. determined by the relationship between output and the price level d. endogenous e. equal to the supply of gold reserves ANS: B DIF: Medium REF: 8.2 TOP: II.D. MSC: Understanding 34. According to the quantity theory of money, the price level is: a. exogenous b. determined by the money supply only c. determined by the ratio of the effective quantity of money to the volume of goods d. indeterminate in the long run e. determined by the volume of goods produced ANS: C DIF: Medium REF: 8.2 TOP: II.D. MSC: Remembering 35. According to the quantity theory of money, the price level can be written as: a. d. b. e. c. ANS: C DIF: Easy REF: 8.2 TOP: II.D. MSC: Remembering 36. The essence of the quantity theory of money is that: a. the price level is indeterminate b. in the long run, the only determinant of the price level is the money supply c. in the long run, a key determinant of the price level is the money supply d. only the central bank knows what the price level is e. money cannot pin down the price level ANS: C DIF: Medium REF: 8.2 TOP: II.D. MSC: Understanding 37. Using the quantity theory of money, we can calculate inflation using ________, under the assumption that ________. a. ; velocity is constant b. ; percent change in velocity always equals one c. ; velocity is constantd. ; velocity is variable e. ; velocity is constant ANS: C DIF: Easy REF: 8.2 TOP: II.E. MSC: Applying 38. If long-run real GDP growth is determined by real changes in the economy, the quantity theory of money implies that: a. changes in the money growth rate lead one-for-one to changes in the inflation rate in the long run b. changes in the money growth rate lead one-for-one to changes in the inflation rate but only in the short run c. changes in velocity lead one-for-one to changes in the inflation rate d. changes in the money growth rate lead to a greater than one-for-one change in the inflation rate in the long run e. None of these answers are correct. ANS: A DIF: Medium REF: 8.2 TOP: II.E. MSC: Understanding 39. You are the head of the central bank and you want to maintain 2 percent long-run inflation, using the quantity theory of money. If the real GDP growth is 4 percent and velocity is constant, you suggest a: a. 6 percent interest rate d. 0 percent money supply growth b. 6 percent money supply growth e. 2 percent interest rate c. 2 percent money supply growth ANS: B DIF: Medium REF: 8.2 TOP: II.E. MSC: Analyzing 40. If the real GDP growth is 4 percent per year, the money growth rate is 6 percent, and velocity is constant, using the quantity theory, the inflation rate is: a. 6 percent d. 2 percent b. 4 percent e. 4 percent c. 2 percent ANS: D DIF: Medium REF: 8.2 TOP: II.E. MSC: Analyzing 41. If the real GDP growth is 6 percent per year, the money growth rate is 4 percent, and velocity is constant, using the quantity theory, the inflation rate is: a. 4 percent d. 6 percent b. 2 percent e. 4 percent c. 2 percent ANS: B DIF: Medium REF: 8.2 TOP: II.E. MSC: Analyzing 42. You are the head of the central bank and you want to maintain 2 percent long-run inflation. Using the quantity theory of money, if real GDP growth is 4 percent and velocity is constant, you suggest a: a. 4 percent money supply growth d. 0 percent money supply growth b. 6 percent interest rate e. None of these answers are correct. c. 2 percent money supply growth ANS: E DIF: Medium REF: 8.2 TOP: II.E. MSC: Analyzing43. The implications of the quantity theory of money are the main basis for which of the following quotes? a. “Inflation is always zero in the long run.” b. “Inflation is always and everywhere a fiscal phenomenon.” c. “Inflation is always and everywhere a monetary phenomenon.” d. “Velocity growth should be equal to 2 percent in the long run.” e. “Velocity is always constant.” ANS: C DIF: Medium REF: 8.2 TOP: II.E. MSC: Evaluating Figure 8.1: Money Growth and Inflation in the United States by Decade 44. The data presented in Figure 8.1 confirm that the relationship between inflation and money growth is: a. positive, as suggested by the Fisher equation b. positive, as suggested by money neutrality c. positive, as suggested by the quantity theory of money d. negative, as suggested by the quantity theory of money e. None of these answers are correct. ANS: C DIF: Medium REF: 8.2 TOP: II.E. MSC: Understanding 45. The proposition that changes in money have no real effect on the economy and affect only prices is called: a. inflation d. the neutrality of money b. the classical dichotomy e. the quantity theory c. the quantity equation ANS: D DIF: Easy REF: 8.2 TOP: II.F. MSC: Remembering 46. Empirically, a large amount of evidence suggests that money neutrality ________, but changes in money supply ________. a. holds in the short run; do not affect nominal variables b. does not hold in the long run; can have real effects in the short run c. holds in the short run; can have real effects in the long run d. holds in the long run; can have real effects in the short run e. does not hold in the long run; have an effect on unemployment in the long run ANS: D DIF: Medium REF: 8.2 TOP: II.F. MSC: Understanding 47. The nominal interest rate is: a. the interest rate not adjusted for inflation b. the “advertised” interest rate c. a description of the return in units of currency d. All of these answers are correct. e. None of these answers are correct. ANS: D DIF: Easy REF: 8.3 TOP: III. MSC: Understanding48. The real interest rate is: a. the interest rate not adjusted for inflation b. the “advertised” interest rate c. a description of the return in units of currency d. All of these answers are correct. e. None of these answers are correct. ANS: E DIF: Easy REF: 8.3 TOP: III. MSC: Understanding 49. The real interest rate describes: a. the net return to government bonds b. the rate of return adjusted for inflation c. the rate of return in units of a currency d. the return with an interest rate equal to zero e. the rate of return in real goods ANS: B DIF: Easy REF: 8.3 TOP: III. MSC: Understanding 50. Let r denote the real interest rate and i denote the nominal interest rate; these two interest rates are related by: a. d. b. e. None of these answers are correct. c. ANS: C DIF: Easy REF: 8.3 TOP: III. MSC: Applying 51. Let r denote the real interest rate, i denote the nominal interest rate, and  denote the rate of inflation. The equation is called: a. the money supply d. the quantity theory of money b. the quantity equation e. money neutrality c. the Fisher equation ANS: C DIF: Easy REF: 8.3 TOP: III. MSC: Applying 52. Suppose you put $100 dollars in the bank on January 1, 2013. If the annual nominal interest rate is 5 percent and the inflation rate is 5 percent, you will be able to buy ________ worth of goods on January 1, 2014. a. $90 d. $105 b. $110 e. $95 c. $100 ANS: C DIF: Medium REF: 8.3 TOP: III. MSC: Analyzing 53. Suppose you put $100 dollars in the bank on January 1, 2013. If the annual nominal interest rate is 5 percent and the inflation rate is 2 percent, you will be able to buy ________ worth of goods on January 1, 2014. a. $93 d. $105 b. $107 e. $99 c. $103ANS: C DIF: Medium REF: 8.3 TOP: III. MSC: Analyzing 54. Suppose you put $100 dollars in the bank on January 1, 2013. If the annual nominal interest rate is 2 percent and the inflation rate is 5 percent, you will be able to buy ________ worth of goods on January 1, 2014. a. $95 d. $103 b. $102 e. $3 c. $97 ANS: C DIF: Medium REF: 8.3 TOP: III. MSC: Analyzing 55. If the inflation rate is larger than the nominal interest rate: a. unemployment rises b. the real interest rate is zero c. the real interest rate is negative d. the real interest rate is larger than the nominal interest rate e. Not enough information is given. ANS: C DIF: Medium REF: 8.3 TOP: III. MSC: Analyzing 56. Compared to the nominal interest rate, the real interest rate is: a. negative d. relatively stable b. always smaller e. relatively volatile c. always greater than zero ANS: D DIF: Medium REF: 8.3 TOP: III. MSC: Understanding 57. If the real interest rate is negative, it must mean that: a. in the short run, bond rates can be very volatile b. in the short run, the real interest rate equals the marginal product of capital c. in the short run, the real interest rate can deviate from the marginal product of capital d. it is difficult to predict long-term interest rates e. there is no relationship between long- and short-term interest rates ANS: C DIF: Medium REF: 8.3 TOP: III. MSC: Understanding 58. Practically, the real interest rate is equal to: a. a savings account d. the return to stock markets b. the rate of return to long-term bonds e. the return to housing c. the marginal product of capital ANS: C DIF: Easy REF: 8.3 TOP: III. MSC: Understanding 59. A risk a bank takes on by offering long-term fixed interest rate loans is: a. the loss of real returns due to anticipated inflation b. the gain that could be made from offering short-term loans c. the loss of real returns due to an unexpected inflation surprise d. the gains that could have been made if the money were invested in an alternative asset e. the loss of customers wanting flexible interest loansANS: C DIF: Medium REF: 8.4 TOP: IV. MSC: Understanding 60. When calculating fixed retirement payments, it is important not to forget: a. changes in flexible interest rates b. the decline in the payment’s value due to inflation c. the increase in the payment’s value due to inflation d. rates of return in other markets e. the price of tea in China ANS: B DIF: Easy REF: 8.4 TOP: IV. MSC: Evaluating 61. By purchasing a fixed-rate 30-year mortgage, inflation risk is: a. eradicated b. spread equally to the borrower and lender c. passed from the lender to the borrower d. passed from the borrower to the lender e. borne by the government ANS: D DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating 62. If you decide to buy a house with an adjustable-rate mortgage (ARM), you are: a. exposing yourself to inflation risk b. reducing your inflation risk c. passing inflation risk to the lender d. taking on some of the lender’s inflation risk e. increasing your mortgage payment ANS: A DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating 63. Negative inflationary surprises lead to: a. an increase in the real interest rate b. a redistribution of wealth from borrowers to lenders c. a decline in the nominal interest rate d. a decline in inflation risk for lenders e. a redistribution of wealth from lenders to borrowers ANS: B DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating 64. If income tax rates are based on nominal income, as inflation increases, taxpayers will see: a. an increase in their real incomes b. their taxes fall as their incomes fall c. their taxes rise even though their real incomes are falling d. an increase in the nominal income e. their taxes fall even though their real incomes are rising ANS: C DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating 65. If some goods’ prices adjust more quickly than others, there is: a. a perfect short-run allocation of resourcesb. a short-run misallocation of resources c. no inflation d. a hyperinflation e. a deflation ANS: B DIF: Easy REF: 8.4 TOP: IV. MSC: Understanding 66. Inflation ________ price volatility and ________ allocative efficiency. a. decreases; increases d. increases; decreases b. decreases; leaves unchanged e. leaves unchanged; increases c. increases; leaves unchanged ANS: D DIF: Medium REF: 8.5 TOP: IV. MSC: Understanding 67. During times of high inflation, people hold ________ and must incur ________. a. less savings; lower interest rates b. more money; lower interest rates c. less money; higher shoe-leather costs d. more savings; shoe-leather costs e. less savings; higher transaction costs ANS: C DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating 68. The costs associated with changing prices in times of inflation are called: a. inflation risks d. shoe-leather costs b. price staggering e. menu costs c. transaction costs ANS: E DIF: Easy REF: 8.4 TOP: IV. MSC: Understanding 69. One problem with unexpected changes in inflation is that: a. it steadily erodes real income b. it often comes in surprising and unpredictable ways c. nominal interest rates are not indexed to inflation d. fixed-rate mortgages are not adjusted for inflation e. price staggering occurs ANS: B DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating 70. To minimize what was believed to be a wage-price spiral, the ________ administration ________. a. Reagan; increased corporate income b. Carter; increased interest rates c. Clinton; released oil from the strategic reserves d. first Bush; increased taxes e. Nixon; imposed price controls ANS: E DIF: Medium REF: 8.4 TOP: IV.A. MSC: Understanding 71. The price controls imposed by the Nixon administration lasted for: a. four weeks d. one yearb. six months e. two years c. ninety days ANS: C DIF: Easy REF: 8.4 TOP: IV.A. MSC: Understanding 72. With unanticipated inflation: a. creditors are hurt unless they have an indexed contract, because they get less than they expected in real terms b. debtors with an indexed contract are hurt, because they pay more than they contracted for in nominal terms c. debtors with an unindexed contract lose, because they pay exactly what they contracted for in nominal terms d. creditors with indexed contracts gain, because they receive more than they contracted for in nominal terms e. debtors with an indexed contract are hurt, because they pay more than they contracted for in real terms ANS: A DIF: Medium REF: 8.4 TOP: V. MSC: Evaluating 73. According to the government’s budget constraint, if the government spends more than it generates in taxes, it can raise revenues by: a. printing money d. privatizating b. decreasing its debt e. increasing interest rates c. lowering interest rates ANS: A DIF: Easy REF: 8.5 TOP: V. MSC: Applying 74. The right to seignorage is the right to: a. make coins d. borrow from the public b. raise tax revenues e. raise an army c. print money ANS: C DIF: Easy REF: 8.5 TOP: V.A. MSC: Understanding 75. The revenue governments obtain from printing money is called: a. issued debt d. government expenditures b. the inflation tax e. None of these answers are correct. c. raised taxes ANS: B DIF: Easy REF: 8.5 TOP: V.A. MSC: Understanding 76. With an inflation tax: a. everybody loses b. all individuals in an economy feel the pressures equitably c. there is a redistribution of income from owners of real assets to income earners d. there is a redistribution of income from income earners to owners of real assets e. the government has a lot of debt to repay ANS: D DIF: Medium REF: 8.5 TOP: V.A. MSC: Understanding77. A government that relies on seignorage to finance excess government expenditures is the foundation for the following quote: a. “Inflation is always zero in the long run.” b. “Inflation is always and everywhere a monetary phenomenon.” c. “Inflation is always and everywhere a fiscal phenomenon.” d. “Velocity growth should be equal to 2 percent in the long run.” e. “Velocity is always constant.” ANS: C DIF: Easy REF: 8.5 TOP: V.A. MSC: Evaluating 78. ________ prevent(s) governments from being tempted to use seignorage excessively. a. Gold reserves d. Future generations b. The power of bond markets e. Central bank independence c. The government budget constraint ANS: E DIF: Easy REF: 8.5 TOP: V.B. MSC: Understanding 79. According to the quantity equation, the cure for hyperinflation is: a. higher taxes d. All of these answers are correct. b. reducing government spending e. None of these answers are correct. c. reducing money growth ANS: C DIF: Easy REF: 8.5 TOP: V.C. MSC: Understanding 80. The cure for hyperinflation is: a. reducing money growth d. seignorage b. maintaining government spending e. All of these answers are correct. c. lower taxes ANS: A DIF: Medium REF: 8.5 TOP: V.C. MSC: Understanding 81. In the text, the country that experienced the highest inflation rate in 1990 was: a. Afghanistan d. Brazil b. Argentina e. Russia c. Mexico ANS: B DIF: Easy REF: 8.5 TOP: V.C. MSC: Understanding 82. The coordination problem is difficult to solve because: a. policymakers cannot make unified decisions b. aggregate price-setting behavior has built-in inflation inertia c. individual price-setting behavior economywide has built-in inflation inertia d. central banks are controlled by many different interests e. All of these answers are correct. ANS: C DIF: Medium REF: 8.5 TOP: V.C. MSC: Understanding 83. If all price setters are not convinced that high inflation rates will end soon, there is: a. price staggering b. a transfer of wealth from one group to anotherc. substantial menu costs d. a coordination problem e. negative real interest rates ANS: D DIF: Medium REF: 8.5 TOP: V.C. MSC: Understanding TRUE/FALSE 1. Economists often use a rate of inflation that is calculated using all goods EXCEPT vehicles and housing, because prices for these goods are relatively volatile. ANS: F DIF: Easy REF: 8.1 TOP: I. MSC: Understanding NOT: It uses all goods except food and energy. 2. The U.S. dollar is backed by the belief that it has value. ANS: T DIF: Easy REF: 8.2 TOP: II. MSC: Understanding NOT: It is fiat money. 3. Short-term treasury bills are the most liquid form of asset. ANS: F DIF: Easy REF: 8.2 TOP: II. MSC: Understanding NOT: The most liquid are currency and coins. 4. M1 consists of savings and money market accounts. ANS: F DIF: Easy REF: 8.2 TOP: II.A. MSC: Understanding NOT: It includes demand deposits and currency. 5. The velocity of money is defined as the average number of times a dollar is used in a transaction over the course of year. ANS: T DIF: Easy REF: 8.2 TOP: II.B. MSC: Remembering 6. In the quantity equation, the value PtYt is the real GDP. ANS: F DIF: Easy REF: 8.2 TOP: II.B. MSC: Remembering 7. According to the quantity theory of money, the price level is determined by the ratio of the effective quantity of money to the volume of goods. ANS: T DIF: Medium REF: 8.2 TOP: II.B. MSC: Applying 8. Money neutrality is the proposition that changes in money have no real effect on the economy. ANS: T DIF: Easy REF: 8.3 TOP: II.C. MSC: Understanding 9. The costs associated with changing prices are called menu costs.ANS: T DIF: Easy REF: 8.4 TOP: IV. MSC: Understanding NOT: This is because costs are associated with changing prices on menus, and those small costs may prevent the price from changing, even with inflation. 10. An implication of the quantity theory of money is that money growth rates have a less than one-to-one relationship with inflation. ANS: F DIF: Medium REF: 8.2 TOP: II.C. MSC: Understanding NOT: It implies a one-to-one relationship. 11. If the inflation rate is higher than the nominal interest rate, the real interest rate is positive. ANS: F DIF: Easy REF: 8.3 TOP: III. MSC: Applying 12. Compared to the real interest rate, the nominal interest rate has been relatively constant, moving with changes in inflation. ANS: F DIF: Easy REF: 8.3 TOP: III. MSC: Understanding 13. If the real interest rate is less than zero, it implies that the real interest rate deviates from the marginal product of capital in the short run. ANS: T DIF: Easy REF: 8.3 TOP: III. MSC: Understanding 14. If you put $100 in the bank for one year at an annual nominal interest rate of 5 percent and yearly inflation is running at 7 percent, you will be able to buy $105 worth of goods when you pull it out of your account. ANS: F DIF: Medium REF: 8.3 TOP: III. MSC: Analyzing 15. If all goods’ prices adjust simultaneously, there will be a short-term misallocation of resources. ANS: F DIF: Medium REF: 8.4 TOP: IV. MSC: Evaluating NOT: Because all prices adjust simultaneously, resources will be allocated efficiently. 16. If a bank offers you a 30-year fixed-rate mortgage, it is passing inflation risk over to you. ANS: F DIF: Easy REF: 8.4 TOP: IV. MSC: Understanding NOT: Because the nominal interest rate is fixed, the real interest rate can change dramatically with changes in inflation. 17. Inflationary surprises transfer wealth from lenders to borrowers. ANS: F DIF: Medium REF: 8.4 TOP: IV. MSC: Understanding NOT: They transfer wealth from borrowers to lenders, provided the terms of the agreement are fixed.18. The right to seignorage is the right to apply income taxes. ANS: F DIF: Easy REF: 8.5 TOP: V.A. MSC: Understanding NOT: It is the right to print money. 19. In the United States, decisions about monetary policy are conducted by the Federal Reserve, which is likely to lower income taxes. ANS: F DIF: Easy REF: 8.5 TOP: V.B. MSC: Evaluating NOT: Monetary policy is conducted by the Fed to reduce the temptation of the government to use inflation taxes. 20. In times of high inflation, shoe-leather costs rise. ANS: T DIF: Medium REF: 8.4 TOP: IV. MSC: Understanding NOT: Shoe-leather costs are defined as the costs of going to the bank. With higher rates of inflation, people spend more time going to the bank. 21. The Federal Reserve believed that the productivity slowdown in the 1970s was a long-lived recession and therefore increased the supply of money. ANS: F DIF: Medium REF: 8.6 TOP: VI. MSC: Understanding NOT: The Fed believed the slowdown was a temporary negative productivity shock. 22. The high rate of inflation in the United States in the late 1970s and early 1980s was due to high inflation taxes. ANS: F DIF: Easy REF: 8.6 TOP: VI. MSC: Understanding NOT: It was due to a host of problems: high oil prices, loose monetary policy, and the “productivity slowdown.” SHORT ANSWER Table 8.1 Year CPI Year CPI 1970 40.8 2000 181.3 1975 53.9 2005 200.9 1980 80.8 2010 221.3 1985 109.3 2011 225.0 1990 135.5 2012 229.8 1995 161.2 (Source: U.S. Bureau of Labor Statistics) 1. Considering the end-of-year CPI data in Table 8.1: (a) Calculate the rate of inflation between 1970 and 1975 and between 1995 and 2000. (b) Calculate the average rate of inflation for 1970–1975 and 1970–1980.(c) Calculate the average rate of inflation for 2000–2012 and 2005 2010. (d) Briefly comment on your results. ANS: (a) We use the equation . For 1970–1975: 100  (53.9/40.8 1) = 32.11%; for 1995–2000: 100  181.3/(161.2 1 ) = 12.47%. (b) We use For 1970–1975: 100  [(53.9 /40.8 )1/6 – 1] = 4.75%; for 1970–1980: 100  [(80.8/40.8 )1/11 – 1] = 6.41%. (c) We use For 2000–2012: 100  [(229.8/181.3 )1/13 – 1] = 1.84%; for 2005–2010: 100  [(221.3/200.9 )1/6 – 1] = 1.62%. (d) The 2000s were a relatively low inflation period compared to other decades analyzed. Indeed, in some periods inflation was negative. DIF: Difficult REF: 8.1 TOP: I. MSC: Evaluating 2. Briefly discuss what makes up the monetary base, M1, and M2. ANS: (a) Monetary base = currency + reserves; (b) M1 = demand deposits + currency; (c) M2 = M1 + savings accounts + money market accounts. DIF: Easy REF: 8.2 TOP: II.A. MSC: Remembering 3. Write down the quantity equation in growth terms, and identify each variable. (a) According to the quantity theory of money, what determines the long-run rate of inflation? (b) If real output growth is 3 percent and velocity is constant, what must the growth rate of money be to ensure that inflation is 5 percent? ANS: The quantity equation is given by MtVt = PtYt, where M is money supply, V is velocity, P is the price level (GDP deflator or CPI), and Y is real GDP. In growth terms this is: (a) According to the quantity theory of money, in the long run velocity is constant; real GDP growth is given by productivity changes (from the growth chapters). Thus, the long-run rate of inflation changes one-for-one with the growth rate of money, the only policy variable (money supply): .(b) Rearranging, and noting , we have . DIF: Medium REF: 8.2 TOP: II.D. MSC: Analyzing 4. Below is the three-year bond real interest rate from 2000–2012. Explain why the real interest rate is positive for most of the 2000s and what explains it being negative in 2008–2009 and 2011–2012. Figure 8.2: Three-Year Bond Real Interest Rate: 2000–2012 (Source: Federal Reserve Economic Data, St. Louis Federal Reserve) ANS: The real interest rate, r, is given by Fisher equation , where i is the nominal interest rate and p is the rate of inflation. If , the real interest rate is positive/negative. Clearly, throughout most of the 2000s, , but this flipped in 2008–2009 when inflation accelerated due to rising oil prices. The information is not present, but the negative rates post mid-2010 are due to low bond yields and “normal” rates of inflation. DIF: Difficult REF: 8.3 TOP: III. MSC: Evaluating 5. Explain how increases in government expenditures can lead to inflation. ANS: The government budget constraint is given by ; G is government expenditures, T is tax revenues, is borrowing (growth of debt), and is the growth of money. If , the government must borrow and/or “print money” to finance expenditures. As the public’s willingness to buy government debt declines, the government must print money to finance expenditures. From the quantity theory , and as inflation accelerates. This is called the inflation tax or seignorage. DIF: Difficult REF: 8.5 TOP: V. MSC: Evaluating 6. Briefly explain the cause of the Great Inflation in the 1970s. ANS:With oil prices rising as OPEC cut supply, inflation began to accelerate. This prompted a recession with rising unemployment. To fight the recession the Fed increased money supply. Coupled with the decline in productivity in 1970s this ramped up inflation, from the quantity theory: . DIF: Medium REF: 8.6 TOP: VI. MSC: Evaluating