Chapter 13

In the event of a recession, which of the following is the most likely policy stance of those who advocate a passive approach to economic policy?

Do nothing

According to the active policy position, eliminating a contractionary gap

should be accomplished by stimulating aggregate demand

According to those who favor an active approach to policy, how can the economy shown in Exhibit 16-1 attain equilibrium at potential output?

Either the money supply or government spending should be increased.

An economy that self-corrects an expansionary gap will experience stagflation.

True

The formulation of active policy is

more effective if the natural unemployment rate can be easily calculated

Suppose that policy makers are concerned about a shortage of long-term capital investment. To remedy the problem, various plans to cut capital gains taxes have been suggested. The delay in picking a plan is called the

decision-making lag

If the time for an economy to self-correct is shorter than the active policy lags,

active policy will likely be destabilizing

Those who favor an active approach to policy believe that

despite the lags involved, implementing discretionary policy is preferable to inaction

According to the rational expectations school,

people form expectations, in part, by considering the probable future actions of government policy makers

Some economists believe that when workers and firms come to expect an expansionary monetary policy and the resulting inflation,

the expansionary monetary policy will have no effect on either output or employment

If resource owners anticipated a monetary growth rate of 6 percent, but the money supply actually grew at only 2 percent,

output would fall

The time inconsistency problem arises when

policy makers have an incentive to mislead people about their monetary policy intentions

Economists of the rational expectations school

believe workers and firms make decisions based on what they think monetary policy will be in the future

Along the short-run Phillips curve, when the unemployment rate goes down,

inflation rate goes up

Suppose the economy had been operating along a given short-run Phillips curve for several years and then experienced a year of stagflation. The year of stagflation would

be represented as a point above the short-run Phillips curve

An increase in the expected inflation rate will

shift the short-run Phillips curve upward and to the right

Some economists believe that in the long run the unemployment rate is independent of the inflation rate and so the Phillips curve becomes a vertical line.

True

If the economy in Exhibit 16-4 is initially at point c and aggregate demand decreases, the economy will (in the long run)

move toward point d

According to the natural rate hypothesis, the economy tends toward

the natural rate of unemployment in the long run

According to the natural rate hypothesis, unemployment can

be maintained below the natural rate only at the cost of ever-increasing inflation