Question

 

(1)There is no long-run tradeoff between inflation and unemployment because

• A inflation always returns to the baseline level.
• B real GDP always returns to potential GDP.
• C potential GDP declines as the inflation rate raises.
• D the aggregate demand curve always shifts back to its baseline position.

(2)The “Goldilocks economy” refers to a situation in which (Check all correct answers.)

A   inflation is lower than the target rate.
B   inflation is equal to the target rate.
C   real GDP is equal to potential GDP.
D   real GDP is above potential GDP.

(3)Quantitative easing increases all the following EXCEPT

A   interest rates.
B   the money supply.
C   reserves.
D   the monetary base.

(4)The interest rate on loans banks pay when they borrow from the Fed is called

A   the federal funds rate
B   the Treasury bill rate.
C   the prime rate.
D   the discount rate.

(5)If the Fed lowers the federal funds rate,

A   the money supply increases.
B   all other interest rates decrease.
C   all other interest rates increase.
D   the money supply decreases.

(6)Which of the following affects the Fed's interest rate decisions? (Check all correct answers.)

A   the level of wages relative to output prices.
B   the level of potential GDP.
C   the level of inflation.
D   the gap between real GDP and potential GDP.

Answer 1

(1) Potential GDP declines as the inflation rate raises.

Philips curve shows the long run relation between unemployment and inflation rate in an economy. The increasing inflation rate will increase the unemployment rate in long run. This will worsen the economic conditions. Thus the potential GDP will decline and leads to higher unemployment in the economy. At the same time, the unemployment will not fall below the NAIRU. The rising inflation rate in long run will negatively affect the real GDP and the potential GDP.

(2) Inflation is lower than the target rate.

Goldilocks economies are the economies which are safe from economic drawbacks. This kind of economies is sustainable and this will shows lower level of inflation rate. This lowering inflation will help to implement proper monetary policy with all its expected results. These economies can be act as market friendly economies with proper monetary policy. Here the increasing money supply will not lead to high inflation rate. These goldilocks economies are the ideal type of economies with steady economic growth without any recession or inflation rate.

(3) Interest rate.

Quantitative easing is the process by which the central bank will buy government bonds to supply large amount of money to the economy. The increasing supply of money will increase the reserves and monetary base. At the same time, the increasing money supply will reduce the interest rate to increase the investment rate and level of production. Quantitative easing shows the increase in the total level of reserves.

(4) Discount rate

This is the rate at which the central bank provides loans and advances to the commercial banks. This rate will determine the present value of future cash flows. Federal fund rate is the targeted interest rate which shows the limit of the commercial bank to borrow and lend their excess reserves to each other. The prime rate used to determine the good credit backup of the customers in commercial banks. Treasury bill rate was used in the auction procedures in the secondary market.

(5) All other interest rates decrease.

The lowering of federal fund rates was aimed to stimulate the economic growth. The lowering of all interest rate will attract the investors and raise the level of investment. This lowering interest rate will lower the cost of borrowing and increase the overall production level through higher level of investment. Sometime these rates will increase to make a control over the inflation rate.

(6) Level of inflation.

The Fed makes control over the inflation rate through changing the interest rate. The rising interest rate will make a control over the money supply and this will reduce the inflation rate. The interest rate will increase with respect to increasing demand for money. This interest rate raise will increase the cost of borrowing also.