Final Exam

Correct answers are in italics

Part I. Multiple Choice (69 points). Choose the single best answer for the following 23 questions.

1. The Fed's game plan can be best described as follows:
a. The Fed uses its policy tools to adjust intermediate targets that directly impact its operating targets in way that allows the Fed to achieve its goals.
b. The Fed uses its policy tools to adjust operating targets that directly impact its intermediate targets in a way that allows the Fed to achieve its goals.
c. The Fed uses its operating targets to adjust its intermediate targets in that directly impact its policy in a way that allows the Fed to achieve its goals.
d. none of the above.

2. Which of the following criteria must be satisfied when selecting an intermediate target?
a. The variable must be measurable and frequently available.
b. The variable must be controllable with the use of the Fed's policy tools.
c. The variable must have a predictable impact on the policy goal.
d. all of the above.

3. Select the false statement:
a. One potential operating target is reserves.
b. One potential intermediate target is the money stock.
c. One potential intermediate target is the monetary base.
d. One potential operating target is the federal funds rate.
e. none of the above (i.e., all of the above are true).

4. Which of the following will shift the aggregate supply curve leftward?
a. A decrease in the price of crude oil.
b. A decrease in the value of the dollar.
c. A technological improvement that increases worker productivity.
d. Expectations of a higher price level.
e. b and d.

5. Suppose taxes rise at the same time the Fed decreases the money supply at the same time. Which of the following statements is true?
a. A Keynesian would believe that aggregate output and the price level would definitely rise in the short run.
b. A Monetarist would believe that aggregate output and the price level would definitely fall in the short run.
c. A Keynesian would believe that aggregate output and the price level would definitely fall in the short run.
d. b and c.
e. none of the above.

6. If the economy experiences both a lower price level and falling unemployment, one can reasonably infer
a. that the aggregate supply curve has shifted to the right.
b. that the aggregate supply curve has shifted to the left.
c. that the aggregate demand curve has shifted to the right.
d. that the aggregate demand curve has shifted to the left.

7. Assume government spending falls. According to the monetarists, the interest rate will , consumer and investment spending will_____, and aggregate demand will_____
a. increase; decrease; increase.
b. decrease; increase; increase.
c. increase; increase; not change.
d. decrease; increase; not change.
e. none of the above.

8. Suppose the exchange rate falls. Using the aggregate supply and demand model, which of the following statements is true about the U.S. economy in the short run?
a. The price level will definitely rise but aggregate output may rise or fall.
b. The price level and aggregate output will definitely rise.
c. Aggregate output will definitely fall but the price level may rise or fall.
d. Aggregate output will definitely rise but the price level may rise or fall.
e. None of the above.

9. A one-shot increase in wages due to a successful wage push by labor unions causes
a. continual inflation.
b. a one-shot increase in the price-level.
c. a one-shot increase in unemployment.
d. both (a) and (c) of the above.
e. both (b) and (c) of the above.

10. Theoretically, demand-pull inflation occurs when
a. unemployment is above the natural rate of unemployment.
b. unemployment is below the natural rate of unemployment.
c. wages rise relative to prices.
d. none of the above.

11. James, an aspiring economist, is interested in knowing if government deficits have been a factor in explaining rapid money growth in her country in the past twenty years. Which of the following would suggest to James that government deficits would help explain the rapid money growth?
a. A decrease in the ratio of money to monetary base.
b. An increase in the ratio of currency to demand deposits.
c. A decrease in the ratio of money to government debt.
d. An increase in the ratio of government debt to GNP.
e. None of the above.

12. If expectations about policy affect how wages are set, then the case for a(n) policy is much stronger.
a. activist.
b. nonactivist.
c. interventionist.
d. stabilization.

13. The time that it takes for a policy to actually have an impact on the economy, once it has been implemented, is called the:
a. effectiveness lag.
b. implementation lag.
c. legislative lag.
d. action lag.
e. inside lag.

14. Suppose the public anticipates an increase in government spending of 10%, but government spending rises less than 10%. Which of the following statements is true in the short run?
a. A New Keynesian economist would argue that aggregate output would definitely fall.
b. A New Keynesian economist would argue that aggregate output would definitely rise.
c. A New Keynesian economist would argue that aggregate output would definitely remain unchanged.
d. A New Keynesian economist would argue that aggregate output may rise or fall.

16. Assume that the economy is characterized by sticky wages and prices, and rational expectations. If the Fed wishes to decrease the price level by decreasing the money supply, how will the preannouncement of such a policy influence the policy's effectiveness?
a. The preannouncement eliminates the policy's effectiveness.
b. The preannouncement diminishes the policy's effectiveness.
c. The preannouncement has no effect on the policy's effectiveness.
d. The preannouncement enhances the policy's effectiveness.

18. While playing racquetball, Tricia argues that the Federal Open Market Committee should quickly expand the money supply in an attempt to return the economy to full employment. One can infer from her argument that Tricia is
a. either a new classical economist or a traditional economist.
b. either a new classical economist or a new Keynesian economist.
c. definitely not a new classical economist.
d. definitely not a new Keynesian economist.

19. The Federal Open Market Committee consists of:
a. the five senior members of the seven-member Board of Governors.
b. the seven members of the Board of Governors and seven presidents of the regional Fed banks.
c. the seven members of the Board of Governors and five presidents of the regional Fed banks.
d. the twelve regional Fed bank presidents and the chairman of the Board of Governors.

20. Supporters of the current system of Fed independence believe that a less autonomous Fed would
a. adopt a short-run bias toward policymaking.
b. pursue overly expansionary monetary policies.
c. be more likely to create a political business cycle.
d. do each of the above.

21. Suppose the Fed takes the following actions. Which of these would not be consistent with the theory of bureaucratic behavior?
a. The Fed starts to focus on controlling the monetary base and the money supply rather than stabilizing interest rates.
b. The Fed imposes a penalty discount rate.
c. The Fed announces two more monetary targets.
d. The Fed lobbies for more regulatory power over the banking system.
e. a and b.

22. If the float is predicted to increase because of unseasonably bad weather, the Fed will likely engage in a to temporarily reserves in the banking system.
a. repurchase agreement; decrease.
b. repurchase agreement; increase.
c. matched sale-purchase agreement; decrease.
d. matched sale-purchase agreement; increase.

23. The most common type of discount loan that the Fed extends to banks is called:
a. seasonal credit.
b. extended credit.
c. adjustment credit.
d. installment credit.

Part II. Essays (30 points). Answer 2 of the following 3 questions.

1. Suppose the Congress announces that it will decrease taxes by 15%. If the public believes Congress but Congress actually decreases taxes by more than 15%. Be sure to include the appropriate diagram for each model.

(a) What will happen to aggregate output and the price level, in the short run, if the new classical view of the economy is correct? (6 points)

The diagram shows the aggregate demand curve increasing more than anticipated. Thus, AD shifts more than AS and so the price level and output rise.

(b) What will happen to aggregate output and the price level, in the short run, if the New Keynesian model is correct? (6 points)

The diagram shows the aggregate demand curve increasing more than anticipated. Thus, AD shifts more than AS and so the price level and output rise.

(c) Compare the results on aggregate output and the price level between the two models. (3 points)

The price level rises more under the New Classical model than the New Keynesian model, while the output level rises more under the New Keynesian model than the New Classical model.

2. Assume the following two events occur. First, a monsoon occurs that destroys 50% of the crops planted in the U.S. Second, The Federal Reserve increases the money supply. Assume the traditional aggregate supply and demand model is the correct description of the economy. Be sure to explain the rationale behind your answers.

(a) Draw the diagram that includes short run and long run effects (6 points).

The diagram shows the aggregate supply curve shifting left and the aggregate demand curve shufting right.

(b) Describe the short-run effects, separately and together, of these events on the price level and aggregate output using the diagram above (6 points).

The monsoon will raise the costs of production and thus lead to a leftward shift in AS. This shift tends to decrease output and raise the price level. The increase in money supply will shift rightward AD and thus tend to increase the price level and output. The net effect is an increase in price level and an ambiguous output level. If the AS shift is greater than the AD shift the output will fall and it will rise if the AS shift is less than the AD shift.

(c) Describe the long-run effects on the price level and aggregate output (3 points).

Assuming AD shifted more than AS, output is above the natural rate, the economy is a "tight" labor market. Firms will bid up wages trying to hire more workers and thus increase production costs and shift AS leftward. This results in a decrease in output and a higher price level. The long run result will be a higher price level and no change in output.

3. Answer the following 5 parts of this question.

(a) Name three sources of the Fed's independence. (3 points)

(i) Board of Governors have long terms that insulate them from political pressure; (ii) the Federal Reserve has an independent source of funds; and (iii) the Chairman of the Board of Governors's term may overlap the President's term.

(b) Explain argument #1 against independence of the Fed. (4 points)

The Fed has not used it's freedom successfully in the past. Milton Friedman has charged that the Fed was "criminally inept" in the Depression, since it didn't stop the 1/3 decline in the money supply between 1929 and 1932 and doubled reserve requirements in 1936. Also, the evidence suggests Arthur Burns conducted expansionary monetary policy before the 1972 election, to prevent George McGovern from being elected President.

(c) Explain argument #2 against independence of the Fed. (4 points)

Without coordination, monetary and fiscal policy may be working in opposing directions (i.e., expansionary fiscal policy and contractionary monetary policy). Government policy would have a larger impact if both monetary and fiscal policy worked in the same direction.

(d) Explain argument #3 against independence of the Fed. (4 points)

It is undemocratic to have monetary policy under a group unaccountable for its actions. It is impossible to replace Board of Governors members who are not performing their jobs well, while incompetent politicians can be replaced every election day.