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1. The quote “Inflation is always and everywhere a monetary phenomenon” is attributed to:
a. Karl Marx.
b. Thomas Sargent.
c. Milton Friedman.
d. Alan Greenspan.
e. David Ricardo.
ANS: C DIF: Easy REF: 8.1
MSC: Remembering
TOP: I.
2. The quote “Inflation is always and everywhere a fiscal phenomenon” is attributed to:
a. Adam Smith.
b. Thomas Sargent.
c. Karl Marx.
d. Alan Greenspan.
e. David Ricardo.
ANS: B DIF: Easy REF: 8.1
MSC: Remembering
3. The inflation rate is calculated as the:
a. overall price level.
b. change of the price level.
c. percent change in the price level.
TOP: I.
d. difference in the price level.
e. percent change in output.
ANS: C DIF: Easy REF: 8.1
MSC: Remembering
4. If Pt is the price level in time, t, inflation is calculated as:
a. 1/Pt . d. .
b.
c.
TOP: I.
e.
ANS: E DIF: Moderate REF: 8.1
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
MSC: Understanding
TOP: I.
TOP: I.
6. What is a critical factor that 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 Baghdad, Iraq
d. Billy Carter’s beer
e. Margaret Thatcher
ANS: A DIF: Moderate 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
b. Volcker; the Soviet Union
c. Volcker; inflation
d. Bernanke; unemployment
e. Powell; Ayatollah Khomeini
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
b. $7.36
c. $1.16
d. $0.43
e. $0.14
ANS: C DIF: Moderate REF: 8.1 TOP: I.A.
MSC: Analyzing
9. In 2015, The Avengers: Age of Ultron generated about $191.2 million on its opening weekend. In 2007, Spider Man 3 generated $151.1 million on its opening weekend. If the CPI in 2000 was 100, the CPI in 2007 was 113.4, and the CPI in 2015 was 137.6, ________ is the larger single-day grossing movie, with about ________ million in revenues in 2000 dollars.
a. Spider Man; $168.6
b. Spider Man; $133.6
c. Avengers; $138.9
d. Spider Man; $171.3
e. Avengers; $263.2
ANS: C DIF: Difficult REF: 8.1 TOP: I.A.
MSC: Evaluating
10. In 2015, the Wendy’s Junior Cheeseburger Deluxe was on the “Right Price Right Size” menu and was priced at $1.89. If the CPI in 1979 was 72.6 and the CPI in 2015 was 237.0, what is the price of a 2015 cheeseburger in 1979 dollars?
a. $4.28
b. $8.06
c. $0.97
d. $0.58
e. $6.17
ANS: D DIF: Moderate REF: 8.1 TOP: I.A.
MSC: Analyzing
11. Sometimes when discussing inflation, we use a measure of inflation that excludes ________ prices from its calculation because these prices tend to be volatile.
a. commodity and energy
b. food and energy
c. housing
d. food and housing
e. energy and housing
ANS: B DIF: Easy REF: 8.1 TOP: I.A.
MSC: Understanding
12. In the United States, money is backed by:
a. oil.
b. gold.
d. no physical commodity.
e. None of these answers is 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
b. commodity
c. fiat
d. intrinsic
e. None of these answers is correct.
ANS: C DIF: Easy REF: 8.2 TOP: II.
MSC: Understanding
14. Money made with silver, gold, and chocolate are examples of ________ money.
a. fiat
b. commodity
c. backed
d. government
e. None of these answers is correct.
ANS: B DIF: Easy REF: 8.2 TOP: II.
MSC: Evaluating
15. A country on the silver standard uses:
a. coins.
b. fiat money.
c. bond money.
d. commodity money.
e. None of these answers is correct.
ANS: D DIF: Easy REF: 8.2 TOP: II.
MSC: Understanding
16. Fiat money has value because:
a. it is backed by gold.
b. people believe it has value.
c. it has intrinsic value.
d. it is backed by silver.
e. None of these answers is correct.
ANS: B DIF: Easy REF: 8.2 TOP: II.
MSC: Understanding
17. Fiat money has value because:
a. people believe it has value.
b. it is backed by silver.
c. it is backed by gold.
d. it has intrinsic value.
e. it is a commodity.
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
MSC: Understanding
TOP: II.A.
19. The measure of money that includes demand deposits and currency only is called:
a. M0.
b. MZ.
c. M2.
d. M1.
e. MB.
ANS: D DIF: Easy REF: 8.2
MSC: Understanding
20. M2 includes M1 and:
a. large time deposits.
b. overnight repurchase agreements.
c. savings accounts.
TOP: II.A.
d. long-term bonds.
e. gold reserves.
ANS: C DIF: Easy REF: 8.2
MSC: Understanding
TOP: II.A.
21. If you withdraw $100 from your checking account and deposit it in your savings account:
a. M1 rises and M2 falls.
b. both M1 and M2 rise.
c. M1 falls by $50 and M2 rises by $50.
d. the monetary base rises.
e. M1 falls and M2 is unchanged.
ANS: E DIF: Easy REF: 8.2
MSC: Understanding
22. 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
MSC: Understanding
23. In dollar amounts, which of the following is the largest?
a. MB
b. M2
c. M1
d. currency
TOP: II.A.
TOP: II.A.
e. demand deposits
ANS: B DIF: Easy REF: 8.2
MSC: Understanding
24. Alternative forms of money include:
a. frequent flier miles.
b. gift cards.
c. pre-paid debit cards.
d. PayPal.
TOP: II.A.
e. All of these answers are correct.
ANS: E DIF: Easy REF: 8.2
MSC: Evaluating
25. The velocity of money is:
a. how quickly money can be printed.
b. how quickly individuals spend their incomes.
TOP: II.A.1.
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 is correct.
ANS: C DIF: Easy REF: 8.2 TOP: II.B.
MSC: Remembering
26. The velocity of money is:
a. another way of saying “monetizing the debt.”
b. how quickly individuals spend their incomes.
c. a measure of liquidity.
d. how many times individuals are paid per year.
e. the average number of times a dollar is used in a transaction per year.
ANS: E DIF: Easy REF: 8.2 TOP: II.B.
MSC: Remembering
27. In the quantity equation, the value PtYt is:
a. real GDP.
b. nominal GDP.
c. aggregate expenditure.
d. the velocity of money.
e. real money.
ANS: B DIF: Easy REF: 8.2 TOP: II.B.
MSC: Understanding
28. The velocity of money can be calculated from the quantity equation with:
a. PtYt
b. PtYt Mt
c. Mt /Pt Yt
d. PtYt /Mt
e. Mt
ANS: D DIF: Moderate REF: 8.2 TOP: II.B.
MSC: Analyzing
29. Using the quantity equation, if Mt = $1,000, Pt = 1.1, and Yt = 100,000, then the velocity of money is:
a. 100,000.
b. 0.09.
c. 110.
d. 9.09.
e. 0.11.
ANS: C DIF: Moderate REF: 8.2
MSC: Analyzing
TOP: II.B.
30. Using the quantity equation, if Mt = $1,000, Pt = 1.1, and Vt = 11, then real GDP is:
a. $100,000.
b. $0.01.
c. $10,000.
d. $909.19.
e. $826.45.
ANS: C DIF: Moderate REF: 8.2
MSC: Analyzing
31. 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: Moderate REF: 8.2
MSC: Remembering
TOP: II.B.
TOP: II.B.
32. 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: Moderate REF: 8.2
MSC: Understanding
TOP: II.C.
33. Which of the following has NO effect on long-run economic growth?
a. institutions
b. money
c. productivity
d. investment
e. population
ANS: B DIF: Easy REF: 8.2
MSC: Understanding
34. 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: Moderate REF: 8.2
MSC: Understanding
35. In the simple quantity theory of money, the supply of money is:
a. exogenous.
b. a random variable.
TOP: II.C.
TOP: II.D.
c. determined by the relationship between output and the price level.
d. endogenous.
e. equal to the supply of gold reserves.
ANS: A DIF: Moderate REF: 8.2
MSC: Understanding
36. According to the quantity theory of money, the price level is:
a. exogenous.
b. determined by the money supply only.
TOP: II.D.
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: Moderate REF: 8.2
MSC: Remembering
TOP: II.D.
37. According to the quantity theory of money, the price level can be written as:
a. . d. .
b.
c. .
e.
ANS: C DIF: Easy REF: 8.2
TOP: II.D.
MSC: Remembering
38. 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: Moderate REF: 8.2 TOP: II.D.
MSC: Understanding
39. 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 constant
d. ; velocity is variable
e. ; velocity is constant
ANS: C DIF: Easy REF: 8.2 TOP: II.E.
MSC: Applying
40. If long-run real GDP growth is determined by real changes in the economy, the quantity theory of money implies that changes in:
a. the money growth rate lead one-for-one to changes in the inflation rate in the long run.
b. the money growth rate lead one-for-one to changes in the inflation rate, but only in the short run.
c. velocity lead one-for-one to changes in the inflation rate.
d. 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 is correct.
ANS: A DIF: Moderate REF: 8.2 TOP: II.E.
MSC: Understanding
41. 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.
b. 6 percent money supply growth.
c. 2 percent money supply growth.
d. 0 percent money supply growth.
e. 2 percent interest rate.
ANS: B DIF: Moderate REF: 8.2 TOP: II.E.
MSC: Analyzing
42. 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 ________ percent.
a. 6
b. 4
c. 2
d. 2
e. 4
ANS: D DIF: Moderate REF: 8.2 TOP: II.E.
MSC: Analyzing
43. 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 ________ percent.
a. 4
b. 2
c. 2
d. 6
e. 4
ANS: B DIF: Moderate REF: 8.2
MSC: Analyzing
TOP: II.E.
44. 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.
b. 6 percent interest rate.
c. 2 percent money supply growth.
d. 0 percent money supply growth.
e. None of these answers is correct.
ANS: E DIF: Moderate REF: 8.2
MSC: Analyzing
TOP: II.E.
45. 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: Moderate REF: 8.2
MSC: Evaluating
TOP: II.E.
46. The data presented in Figure 8.1 confirm that the relationship between inflation and money growth is ________, as suggested by ________.
a. positive; the Fisher equation
b. positive; money neutrality
c. positive; the quantity theory of money
d. negative; the quantity theory of money
e. None of these answers is correct.
ANS: C DIF: Moderate REF: 8.2
TOP: II.E.
Figure 8.1: Money Growth and Inflation in the United States by DecadeMSC: Understanding
47. The proposition that changes in money have no real effect on the economy and affect only prices is referred to as:
a. inflation.
b. the classical dichotomy.
c. the quantity equation.
d. the neutrality of money.
e. the quantity theory.
ANS: D DIF: Easy REF: 8.2
MSC: Remembering
TOP: II.F.
48. 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: Moderate REF: 8.2
MSC: Understanding
49. 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 is correct.
ANS: D DIF: Easy REF: 8.3
MSC: Understanding
50. 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 is correct.
ANS: E DIF: Easy REF: 8.3
MSC: Understanding
51. The real interest rate describes the:
a. net return to government bonds.
b. rate of return adjusted for inflation.
c. rate of return in units of a currency.
d. return with an interest rate equal to zero.
e. rate of return in real goods.
ANS: B DIF: Easy REF: 8.3
MSC: Understanding
TOP: II.F.
TOP: III.
TOP: III.
TOP: III.
52. Let R denote the real interest rate and i denote the nominal interest rate; these two interest rates are related by:
a. i = . d. i = R/.
b. i = R
c. i = R +
e. None of these answers is correct.
ANS: C DIF: Easy REF: 8.3
MSC: Applying
TOP: III.
53. Let R denote the real interest rate, i denote the nominal interest rate, and denote the rate of inflation. The equation i = R + is called:
a. the money supply.
b. the quantity equation.
c. the Fisher equation.
d. the quantity theory of money.
e. money neutrality.
ANS: C DIF: Easy REF: 8.3
MSC: Applying
TOP: III.
54. Suppose you put $100 in the bank on January 1, 2017. If the annual nominal interest rate is 5 percent and the inflation rate is 5 percent, you will be able to buy ________ worth of inflation-adjusted goods on January 1, 2018.
a. $90
b. $110
c. $100
d. $105
e. $95
ANS: C DIF: Moderate REF: 8.3
MSC: Analyzing
TOP: III.
55. Suppose you put $100 in the bank on January 1, 2017. 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, 2018, valued at 2017’s prices.
a. $93
b. $107
c. $103
d. $105
e. $99
ANS: C DIF: Moderate REF: 8.3
MSC: Analyzing
TOP: III.
56. Suppose you put $100 in the bank on January 1, 2017. 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, 2018, valued at 2017’s prices.
a. $95
b. $102
c. $97
d. $103
e. $3
ANS: C DIF: Moderate REF: 8.3
MSC: Analyzing
57. 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: Moderate REF: 8.3
MSC: Analyzing
TOP: III.
TOP: III.
58. Compared to the nominal interest rate, the real interest rate is:
a. negative.
b. always smaller.
c. always greater than zero.
d. relatively stable.
e. relatively volatile.
ANS: D DIF: Moderate REF: 8.3
MSC: Understanding
59. If the real interest rate is negative, it must mean that:
a. in the short run, bond rates can be very volatile.
TOP: III.
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: Moderate REF: 8.3
MSC: Understanding
60. Practically, in the long run the real interest rate is equal to:
a. a savings account.
b. the rate of return to long-term bonds.
c. the marginal product of capital.
TOP: III.
d. the return to stock markets.
e. the return to housing.
ANS: C DIF: Easy REF: 8.3
MSC: Understanding
TOP: III.
61. A risk a bank takes on by offering long-term fixed interest rate loans is the:
a. loss of real returns due to anticipated inflation.
b. gain that could be made from offering short-term loans.
c. loss of real returns due to an unexpected inflation surprise.
d. gains that could have been made if the money were invested in an alternative asset.
e. loss of customers wanting flexible interest loans.
ANS: C DIF: Moderate REF: 8.4
MSC: Understanding
TOP: IV.
62. 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
MSC: Evaluating
63. 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: Moderate REF: 8.4
MSC: Evaluating
TOP: IV.
TOP: IV.
64. 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: Moderate REF: 8.4
MSC: Evaluating
65. Negative inflationary surprises lead to a(n):
a. increase in the real interest rate.
b. redistribution of wealth from borrowers to lenders.
c. decline in the nominal interest rate.
d. decline in inflation risk for lenders.
e. redistribution of wealth from lenders to borrowers.
ANS: B DIF: Moderate REF: 8.4
MSC: Evaluating
TOP: IV.
TOP: IV.
66. 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: Moderate REF: 8.4
MSC: Evaluating
TOP: IV.
67. If some goods’ prices adjust more quickly than others during a period of high inflation, there is:
a. a perfect short-run allocation of resources.
b. a short-run misallocation of resources.
c. no inflation.
d. a hyperinflation.
e. a deflation.
ANS: B DIF: Easy REF: 8.4
MSC: Understanding
TOP: IV.
68. Inflation ________ price volatility and ________ allocative efficiency.
a. decreases; increases
b. decreases; leaves unchanged
c. increases; leaves unchanged
d. increases; decreases
e. leaves unchanged; increases
ANS: D DIF: Moderate REF: 8.5
MSC: Understanding
TOP: IV.
69. 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: Moderate REF: 8.4
MSC: Evaluating
TOP: IV.
70. When inflation is high and people are forced to make more trips to the bank, this is often referred to as:
a. marginal social cost.
b. hyperinflation.
c. the double coincidence of wants.
d. the neutrality of money.
e. shoe-leather costs.
ANS: E DIF: Moderate REF: 8.4
MSC: Remembering
TOP: IV.
71. The costs associated with changing prices in times of inflation are called:
a. inflation risks.
b. price staggering.
c. transaction costs.
d. shoe-leather costs.
e. menu costs.
ANS: E DIF: Easy REF: 8.4
MSC: Understanding
72. 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: Moderate REF: 8.4
MSC: Evaluating
TOP: IV.
TOP: IV.
73. 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: Moderate REF: 8.4
MSC: Understanding
74. The price controls imposed by the Nixon administration lasted for:
a. four weeks.
b. six months.
c. 90 days.
TOP: IV.A.
d. one year.
e. two years.
ANS: C DIF: Easy REF: 8.4
MSC: Understanding
75. With unanticipated inflation:
TOP: IV.A.
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: Moderate REF: 8.4
MSC: Evaluating
TOP: V.
76. 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.
b. decreasing its debt.
c. lowering interest rates.
d. privatizing.
e. increasing interest rates.
ANS: A DIF: Easy REF: 8.5
MSC: Applying
77. The right to seignorage is the right to:
a. make coins.
b. raise tax revenues.
c. print money.
TOP: V.
d. borrow from the public.
e. raise an army.
ANS: C DIF: Easy REF: 8.5
MSC: Understanding
78. The revenue governments obtain from printing money is called:
a. issued debt.
b. the inflation tax.
c. raised taxes.
TOP: V.A.
d. government expenditures.
e. None of these answers is correct.
ANS: B DIF: Easy REF: 8.5
MSC: Understanding
79. With an inflation tax:
a. everybody loses.
b. all individuals in an economy feel the pressures equitably.
TOP: V.A.
c. there is a redistribution of income from owners of real assets to income earners.
d. there is a redistribution of income from currency holders to owners of real assets.
e. the government has a lot of debt to repay.
ANS: D DIF: Moderate REF: 8.5
MSC: Understanding
TOP: V.A.
80. 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
MSC: Evaluating
TOP: V.A.
81. ________ prevent(s) governments from being tempted to use seignorage excessively.
a. Gold reserves
b. The power of bond markets
c. The government budget constraint
d. Future generations
e. Central bank independence
ANS: E DIF: Easy REF: 8.5 TOP: V.B.
MSC: Understanding
82. According to the quantity equation, the cure for hyperinflation is:
a. higher taxes.
b. reducing government spending.
c. reducing money growth.
d. All of these answers are correct.
e. None of these answers is correct.
ANS: C DIF: Easy REF: 8.5 TOP: V.C.
MSC: Understanding
83. The cure for hyperinflation is:
a. reducing money growth.
b. maintaining government spending.
c. lower taxes.
d. seignorage.
e. All of these answers are correct.
ANS: A DIF: Moderate REF: 8.5 TOP: V.C.
MSC: Understanding
84. In the text, the country that experienced the highest inflation rate in 1990 was:
a. Afghanistan.
b. Argentina.
c. Mexico.
d. Brazil.
e. Russia.
ANS: B DIF: Easy REF: 8.5 TOP: V.C.
MSC: Understanding
85. 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: Moderate REF: 8.5
MSC: Understanding
TOP: V.C.
86. If not all price setters are convinced that high inflation rates will end soon, there is/are:
a. price staggering.
b. a transfer of wealth from one group to another.
c. substantial menu costs.
d. a coordination problem.
e. negative real interest rates.
ANS: D DIF: Moderate REF: 8.5
MSC: Understanding
TOP: V.C.
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 a 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: Moderate 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: Moderate 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
MSC: Understanding
TOP: III.
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
MSC: Understanding
TOP: III.
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 inflation adjusted goods when you pull it out of your account.
ANS: F DIF: Moderate REF: 8.3
MSC: Analyzing
TOP: III.
NOT: The real interest rate is -2% = 5% -7%, so you can only buy $98 worth of inflation adjusted goods.
15. If all goods’ prices adjust simultaneously, there will be a short-term misallocation of resources.
ANS: F DIF: Moderate REF: 8.4
MSC: Evaluating
TOP: IV.
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
MSC: Understanding
TOP: IV.
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: Moderate REF: 8.4
MSC: Understanding
TOP: IV.
NOT: They transfer wealth from borrowers to lenders, provided the terms of the agreement are fixed.
18. The right to seigniorage 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
MSC: Evaluating
TOP: V.B.
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: Moderate REF: 8.4
MSC: Understanding
TOP: IV.
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: Moderate REF: 8.6
MSC: Understanding
TOP: VI.
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 seigniorage.
ANS: F DIF: Easy REF: 8.6
MSC: Understanding
TOP: VI.
NOT: It was due to a host of problems: high oil prices, loose monetary policy, and the “productivity slowdown.”
1. Table 8.1
(Source: U.S. Bureau of Labor Statistics)
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
(c) Calculate the average rate of inflation for 2000
(d) Briefly comment on your results.
ANS:
1975 and 1970
2010 and 2014
1980.
2015.
(a) Use the equation .
For 1970–1975: 100 (53.8/38.8 1) = 38.6%; for 1995–2000: 100 (195.3/172.2 1 ) = 13.4%.
(b) We use
For 1970–1975:
(c) We use the above average inflation equation. For 2000–2010:
(d) The 2000s were a relatively low inflation period compared to other decades analyzed. Indeed, in some periods inflation was negative. Also, inflation was essentially zero in 2015.
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. Table 8.2: Monetary Aggregates (in billions)
(Source: Federal Reserve Board of Governors)
Table 8.2 above contains monetary aggregates for the United States for February and December 2015. Fill in the last three columns for each month. MMF stands for “money market funds.”
ANS:
• M1 = Currency + Travelers Checks + Demand Deposits
• M2 = M1 + Time Deposits + Savings + RMMF
• MB = Currency + Reserves
(Note: These answers are rounded to the nearest $1 billion)
Remembering
4. 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: Moderate REF: 8.2 TOP: II.D. MSC: Analyzing
5. Table 8.3 contains the following variables, growth rates of real GDP, M1, M2, velocity of M1 and M2 (denoted V1 and V2), the federal funds rate (FFR), and the CPI inflation rate. Use the quantity equation to calculate the equilibrium inflation rate using individually M1 and M2. Next, calculate the equilibrium inflation rate assuming the quantity theory of money holds. According to your calculations, which is a better predictor of inflation, M1 or M2? Similarly, which is a better predictor of inflation, assuming the quantity theory holds, or not?
ANS:
The quantity equation is given as
where M is money supply, V is velocity, P is the price level (CPI), and Y is real GDP. We can write this in growth terms as:
,
which we use for the first part of the answer. The quantity theory of money states the velocity is constant (i.e., ). So, this is what we need for the second part. The answer is in the table below: dark shaded areas are the “estimated” inflation rates under the quantity equation V1/2= 0, and without the quantity equation V1/2 0. You don’t need the federal funds rate.
Quickly perusing the results, the estimated inflation rates are closer (really close in 2005) to actual inflation rates when velocity is not assumed to be constant.
DIF: Difficult REF: 8.2 TOP: II.D. MSC: Analyzing
6. Below is the three-year bond real interest rate from 2000–2015. Explain why the real interest rate is positive for most of the 2000s and what explains it being negative in 2008–2009 and 2010–2015. What explains the near-zero real interest rate in 2015? Assuming this interest rate was used to make loans, who benefits from interest rates post-2010?
Figure 8.2: Three-Year Bond Real Interest Rate: 2000–2015
(Source: Federal Reserve Economic Data, St. Louis Federal Reserve)
ANS:
The real interest rate, R, is given by the Fisher equation Rt = it t, where i is the nominal interest rate and 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 mid-2010–2015 are due to low bond yields and “normal” rates of inflation. Throughout 2015, inflation was close to zero and roughly equal to the bond yield; this means the real interest rate is effectively zero.
Benefits accrue to borrowers, as they are essentially being paid to take a loan. This is the unique position the U.S. federal government finds itself in: lenders are essentially paying the government to hold their money for them (i.e., the federal government is being “paid” to borrow).
DIF: Difficult REF: 8.3 TOP: III. MSC: Evaluating
7. The figure below shows the three-month bond yield (solid line) and the inflation rate (dashed). Discuss what has happened to the real three-month bond yield over the period shown, 2003–2015. Are there any “unusual” occurrences over this period?
Figure 8.3: Nominal Three-Month Yield and Inflation
ANS:
To answer this we need the Fisher equation, which states that the real interest rate is equal to the nominal rate minus inflation: Rt = it t. From this you can see that from 2003–2006, 2008–2009, and 2010–2015, the real interest rate was/is negative (as of this writing in 2016, it still is). Secondly, in 2009–2010, and briefly in early 2015, the real interest rate was higher than the nominal interest rate, as inflation was negative; thus, we have: Rt = it ( t) it. Only during the period 2006–2008 were real interest rates below the nominal rate (i.e., “normal”).
DIF: Difficult REF: 8.3
TOP: III.
MSC: Evaluating
8. 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 seigniorage.
DIF: Difficult REF: 8.5
TOP: V.
9. Briefly explain the cause of the Great Inflation in the 1970s.
ANS:
MSC: Evaluating
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 the 1970s, this ramped up inflation, from the quantity theory:
= gM gY .
DIF: Moderate REF: 8.6
TOP: VI.
MSC: Evaluating