Question

5a.

When there is a positive output gap, countercyclical monetary policy might result in a ________ of bonds by the Fed and countercyclical fiscal policy might result in _________ in taxes.

purchase; an increase

sale; a decrease

sale; an increase

purchase; a decrease

b.

During a recession, the combined effect of relatively ________ unemployment and relatively ________ capacity utilization will put downward pressure on prices

low; low

low; high

high; low

high; high

c.

Automatic stabilizers serve to _____________ the economy’s response to exogenous changes in consumption, private planned investment, and net exports, making the multiplier ________.

moderate; larger

moderate; smaller

enhance; smaller

enhance; larger

d.

The government hikes taxes. If the Fed does not fully accommodate this ___________ fiscal action, then interest rates will __________ as aggregate demand changes.

contractionary; increase

expansionary; increase

expansionary; decrease

contractionary; decrease

e.

Declining real planned investment due to ________ interest rates triggered by an expansionary _________ policy Is an example of the crowding out effect.

decreasing; fiscal

increasing; fiscal

decreasing; monetary

increasing; monetary

Answer 1

(5a) Option (3)

With positive output gap, aggregate demand and inflation are higher. So a countercyclical monetary policy will intend to reduce aggregate demand by lowering money supply with sale of federal securities, and a countercyclical fiscal policy will intend to reduce aggregate demand by increasing tax.

(b) Option (3)

During recession, unemployment is high and capacity utilization is low, so price level is lower.

(c) Option (2)

Automatic stabilizers moderate and lessen the economic shocks and lower the multiplier.

(d) Option (4)

Increase in tax is a contractionary fiscal policy tool. Without intervention, higher tax lowers consumption, so aggregate demand decreases, lowering real GDP and output. Lower output and income will decrease the demand for money, shifting money demand curve to left, thus reducing interest rate.

(e) Option (2)

An expansionary fiscal policy (higher government spending or lower tax) will increase budget deficit. So government will increase borrowing, which will increase interest rate, lowering investment.