Question

“There are two forces that cause the economy to grow. One is real, the other is an illusion. The real force—entrepreneurial innovation and creativity—comes naturally as long as government policies do not drive it away. The artificial force is easy money. An increased supply of money, by creating an illusion of wealth, can increase spending in the short run, but this eventually turns into inflation. Printing money cannot possibly create wealth; if it could, counterfeiting would be legal.” [Brian Wesbury, “Economic Rehab,” Wall Street Journal, June 7, 2006, p. A14.] Does this quote illustrate the short-run versus the long-run aspects of monetary policy? Why or why not?

No, printing money does not lead to inflation in the long run; however, money creation must be regulated by the Fed. Yes, output increases in the short run, which creates wealth but can lead to inflation over time. No, expansionary monetary policy has an effect of increasing the price level and wealth both in the short run and in the long run. Yes, in the long run, prices and wages become sticky, making an easy money policy counterproductive.

Which statement explains how sticky wages and prices make monetary policy effective in the short run?

Sticky prices and wages cause producers to increase their costs of production, in which producers will increase the prices of their goods and services. Sticky prices and wages have a positive impact on aggregate demand; an increase in money supply allows individuals to purchase more goods and services. Sticky prices cause the short-run aggregate supply curve to be vertical. Sticky prices cause the short-run aggregate supply curve to slope downward.

Which statement does NOT explain why it is important for the Federal Reserve Board to be independent of the executive branch of the federal government?
	A lack of independence could lead to higher long-run inflation rates. Less independence will lead to lower rates of unemployment and output. Independence allows the Fed to focus on inflation, unemployment, and output. If it were not independent, more political pressures would exist.

Why are supply shocks so much harder than demand shocks for monetary policy to adjust to?
	Monetary policy shifts the aggregate demand curve to the left during demand shocks. Supply shocks can have doubly negative results. Supply shocks do not have an impact on consumers. Monetary policy shifts the aggregate supply curve to the left during demand shocks.

Answer 1

Q. 1 Does this quote illustrate the short-run versus the long-run aspects of monetary policy? Why or why not?

Correct choice: Yes, output increases in the short run, which creates wealth but can lead to inflation over time.

An easy monetary policy will only lead to inflation in the long run. Printing more money doesn't imply that production will rise in the same manner. It may boost AD in the short run.

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Q. 2 Which statement explains how sticky wages and prices make monetary policy effective in the short run?

Correct choice: Sticky prices and wages cause producers to increase their costs of production, in which producers will increase the prices of their goods and services.

Price levels generally don't fall easily, and "stick" to a particular level. At this point, a liberal monetary policy may help in increasing AD.

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Q. 3 Which statement does NOT explain why it is important for the Federal Reserve Board to be independent of the executive branch of the federal government?

Correct choice: Less independence will lead to lower rates of unemployment and output.

In fact, more independence of the Fed will lead to lower unemployment and higher output.

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Q. 4 Why are supply shocks so much harder than demand shocks for monetary policy to adjust to?

Correct choice: Supply shocks can have doubly negative results.

Monetary policy may not work well against supply shocks, due to the possibility of stagflation on one hand, and the liquidity trap on the other.