Question

5. If people anticipate higher inflation, but inflation remains the same then
a. the short-run Phillips curve would shift right and unemployment would rise.
b. the short-run Phillips curve would shift right and unemployment would fall.
c. the short-run Phillips curve would shift left and unemployment would rise.
d. the short-run Phillips curve would shift left and unemployment would fall.

6. If a central bank increases the money supply in response to an adverse supply shock, then which of the following quantities moves closer to its pre-shock value as a result?
a. both the price level and output
b. the price level but not output
c. output but not the price level
d. neither output nor the price level

7. Suppose the budget deficit is rising 3 percent per year and nominal GDP is rising 5 percent per year. The debt created by these continuing deficits is
a. sustainable, but the future burden on your children cannot be offset.
b. sustainable, and the future burden on your children can be offset if you save for them.
c. not sustainable, and the future burden on your children cannot be offset.
d. not sustainable, but the future burden on your children can be offset if you save for them.

8. Which of the following could the government do to decrease the costs of inflation without lowering the inflation rate?
a. Avoid unexpected changes in the inflation rate.
b. Rewrite the tax laws so that nominal gains were taxed instead of real gains.
c. Make policy that would discourage firms from issuing indexed bonds.
d. All of the above are correct.

9. Real interest rates
a. cannot be negative.
b. can be negative only if inflation is negative.
c. can be negative only if inflation is zero.
d. can be negative only if inflation is greater than zero.

Answer 1

5) Answer: (a) The short-run Phillips curve would shift right and unemployment would rise.

The Philips curve represents relationships between inflation and unemployment rates. It states that there exist an inverse relationship between unemployment rates and inflation. If people anticipate higher levels of inflation, there is an expectation of an increase in the nominal income and thus a reduction in the profits made. As a result, with this information as a basis, many workers are let off from work, thus increasing unemployment rates.

6) Answer: (c) output, but not the price level.

When there is a negative supply shock, the output is lesser than full employment level of output and there is inflation and unemployment in the economy causing an overall stagflation. So the central bank increases money supply to reduce unemployment, thus restoring output to it's pre-shock value as a result.

But this option has a side effect of increase prices even further as by increasing money supply, the central bank also increases the existing inflation.

7) Answer: (b)  sustainable, and the future burden on your children can be offset if you save for them.

A budget deficit indicates lower taxes and increased government spending. Although the government is losing a lot of resources, it is likely done to give the economy a head start. Soon, taxes are increased and expenditure is reduced thus setting the government in a break-even position to earn revenue for the money spent for the deficit.

So, if managed properly, the government can achieve a sustainable balance , with minimum inflation and thus can come out of the deficit soon enough the economy has prospered. However, for the future generation, where higher taxes are to be  expected, saving up is very essential to survive and prosper in the future economic condition.

8) Answer: (d) All of the above

The government, with an aim to reduce cost of inflation, without lowering inflation rates has multiple ways to achieve the same as inflation is beneficial in many ways such as reducing value of money, thereby making borrowing cheaper . By avoiding unexpected changes in inflation, anticipation among people is reduced and thus drastic decision that could really cause the result of what people anticipate of can be reduced significantly. If people anticipate a price rise and an inflation and start saving more money for the future, the banks then would not have the necessary funds to lend and thus, currency with the public rise causing increased level of inflation and cost of inflation.

If nominal gains are taxed instead of real gains, then the cost of inflation reduces as nominal gains include inflationary effects and taxing these further reduces the effects of inflationary costs yet keeping the inflationary rates same.

Indexed linked bonds are generally linked with CPI and the principal amount changes with the index to inflation or deflation. Restricting these types of bonds can reduce the effects of inflation as well as costs of inflation as people are discouraged to manipulate these tendencies with an objective of earning higher income.

Thus all the above measures are viable options to reduce the cost of inflation yet keeping the rate of inflation the same.

9) Answer: (d) can be negative only if inflation is greater than zero

As nominal interest rate is bound by zero, when inflation rates are greater than the nominal interest rates and exceeds the nominal interest rate, then the real interest rate becomes negative. In this situation, the borrower earns the difference between the inflation rate and the Interest rate set up by banks to every dollar borrowed by him in a given year.

Say if the federal rate is set at 3% and the inflation rate is at 8.5 %, then in such a situation, the borrower earns 4.5% to every dollar borrowed by him from the bank.