Two particularly controversial propositions of new classical theory relate to the impacts of monetary and of fiscal policy. The real GDP figures reflect changes in the quantity of output and not changes in the, When an economy is producing at full employment output (Y = Y*), One important contribution of Solow's first growth model is the importance of, Diminishing marginal productivity of capital. 133. 5. Recently the U.S. government sent tax rebate checks and the Fed increased the money supply. The active approach to monetary policy involves predetermined rules that are followed virtually without exception. These statements are incorrect because voluntary trade helps both sides. How does aggregate demand change if foreign incomes increase and the dollar appreciates? When self-correcting forces cure a recessionary gap, According to the rational expectations theory, monetary policy is fully anticipated and therefore only affects. Unanticipated contractionary monetary policy shifts, AD to the left and temporarily decreases real GDP, Keynesian analysis implies that a planned expansion in the size of the budget deficit is, proper during economic downturns but inappropriate if the economy is already, The crowding‐out critique suggests that, a reduction in private spending resulting from higher interest rates largely offsets the, If policy makers believe an inflationary boom is about to begin and they want to use fiscal policy to combat it, the Keynesian view indicates that they should. The inflation associated with the oil embargoes of the 1970s illustrated the __________ of the downward-sloping Phillips curve in the long run, as unemployment __________. For example, if people know that expansionary fiscal or monetary policy will cause inflation in the long run, they will factor that into their expectations. Suppose we observe several years of falling inflation rates for an economy. If inflation turns out to be only 4 percent, which of the following is most likely? A basic example of rational expectations theory is a situation in which a consumer delays buying a certain good because, based on his/her observations and experiences, he/she believes that the price will be less expensive in a month. If everything else were constant, this would have led to. In the evolution of growth theory, one error that economists (and others) have made is to focus on __________, without recognizing the importance of other factors like __________. These are, Economists have determined the primary cause of inflation as, When exchange is voluntary between two parties, "Increases in inflation always lead to decreases in unemployment." China has the comparative advantage in producing clothing, The principal of comparative advantage suggests. an expansion in output and a decrease in prices. Your friend graduated from college 10 years ago and started work at a salary of $40,000. According to the rational expectations model, how would an announcement of expansionary monetary policy affect aggregate output? The rational expectations theory clashes with other theories of how we look into the future, such as adaptive expectations, which says that we base our predictions on past and changing trends. B.predicting a higher rate of inflation. Milton Friedman has argued that a reduction in money velocity is partly to blame for the Great Depression. Which type of lag is that? During the 1970s in the United States, inflation rates were _______________ by historical standards and the unemployment rate was _______________ by historical standards. According to the adaptive expectations hypothesis, at the beginning of period 3, decision makers would expect inflation during period 3 to be, According to the Rational Expectations hypothesis, at the beginnig of period 3, decision makers will expect inflation during period 3 to be, In the past year, the value of the Euro has increased from $1.35 to $1.54. Decreases in reserve requirements lead to money supply ________________, because they increase the _______________, China is currently producing 4 units of food and 8 units of clothing. Economic growth around the globe is positively related to. c) It would increase aggregate output in both the short run and the long run. Education levels and reductions in poverty. prolonged high rates of unemployment during the 1930s. D. incorrectly forecasting what will happen to the price level and employment. Which of the following would best explain this phenomenon? The theory of rational expectations is consistent with which statement? c. ineffective in impacting the price level. There is no longer any serious debate about whether monetary policy should be conducted according to rules or discretion. These ideas were formalized by John Muth, who said expectations are rational if they produce predictions equal to the predictions of the underlying economic model. What is the opportunity cost of producing one unit of food in China? During the period __________, the short-run Phillips curve for the United States was farthest from the origin. If the effects of contractionary monetary policy are fully anticipated by decision makers, the policy shifts. According to the rational expectations school, when monetary policy makers do exactly what is expected of them, their efforts to stimulate the economy will have no effect either on output or employment. This article has three major purposes:Illto lay out the basic theoi’v of rational expectations asitrelates to monetary policy in away that stresses its applicability to the real world, 121 to discuss some of the ways that rational expectations models can be altered to give results that refute the policy ineffectiveness proposi- tion and, most importantly, 131 to assess the overall conti-ibution of rational expectations … 132. The rational expectations theory is a concept and theory used in macroeconomics. 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? Those who favor an active approach to policy believe that, despite the lags involved, implementing discretionary policy is preferable to inaction, An economy experiencing an expansionary gap, operates in an environment in which labor shortages drive up money wages, real wages, and prices. lead to a budget deficit during a recession. incorrect because the real income of the economy is limited by the economy's resources, technology, and institutions. The long run Phillip's curve is a horizontal line at the country's natural rate of inflation. In general, the faster inflationary expectations adjust, the less macro policy can influence unemployment. Assuming velocity is stable, the equation of exchange predicts the primary effect of this in the long run will be, A significant increase in inflation over current rates, The Fisher effect implies that the primary long term impact of this action on nominal interest rates is. The theory of rational expectations concludes that: A. the public's expectations can influence the outcome of monetary policy, but not of fiscal policy. The policy surprise may be a The primary focus of this proposal is, The goal of supply side fiscal policy is to, implement institutions that lead to increases in resources or technological advancement, In the Keynesian view of the macroeconomy, increased savings. b. useless in the short run. Increases in foreign income increase aggregate demand; appreciation decreases, During the past 50 years, the long run aggregate supply of the United States has expanded. Which of the following pairs of lags are typically shorter for monetary policy than for fiscal policy? B. Predicitng a higher rate of inflation. Often, economic "experts" advise developing nations to prohibit foreign ownership of domestic assets. 3. If the money supply increases by 7 percent, velocity (of money) does not change, and real GDP grows by 2.2 percent, the price level. capital stock and natural resources; property rights and regulations. C. predicting no change in the rate inflation. If prices and wages are not flexible, an adverse supply shock is most likely to be followed by, For those who favor an active approach, public policy changes are necessary to cure a recessionary gap because, real wages must fall through price increases rather than waiting for money wages to fall, The inflation associated with the oil embargoes of the 1970s resulted in, increased unemployment because aggregate supply fell, When policy makers have an incentive to announce one policy to shape expectations but then pursue a different policy once those expectations have been formed and acted on, there is. An economy in which actual GDP exceeds potential GDP means that, self-correcting forces will shift the SRAS curve to the left, Suppose that in 2004 the Fed announced a policy of rapid growth in the money supply, but then put the brakes on money expansion without any announcement. They were primarilly caused by rapid economic growth in the U.S. stimulating imports, What is the long run average rate of real GDP growth in the United States, What is the long run average unemployment rate in the United States, What is the long run average inflation rate in the United States. When the Federal Reserve unexpectedly increases the money supply, which of the following most likely happens in the short run? As shown in Figure 15-3, if people behave according to rational expectations theory, an increase in the aggregate demand curve from AD1 to AD2 will cause the price level to … Which of the following explains an upward sloping short‐run aggregate supply curve? causes inflation and nominal wages to rise almost immediately as people anticipate the higher inflation rate. d. None of the answers are correct. c) a expansionary monetary policy. The rational expectations theory indicates that expansionary policy will: fail to increase employment because individuals will anticipate it and take actions that will offset its impact. He used the term to describe the many economic situations in which the outcome depends partly on what people expect to happen. During recent times, the U.S. has been running a current account deficit. In its original form, the Phillips curve depicted a situation in which an economy could reduce its unemployment rate by holding the inflation rate steady. Economic theory predicts that the following will result from this regulation, Higher interest rates and a smaller quantity of investment. a) a quantitative easing policy. Only the price level would be higher in the long run with the activist solution. 24 R.J. Barro, Rational expectations and the role of monetary policy existence of an active stabilization policy motivates individuals to reduce expenditures that are aimed at augmenting their information sets. Proponents of all forms of expectations generally agree, underprediction of inflation generally leads to lower unemployment. unemployment falls below the natural rate. Which of the following is true regarding these deficits? What method would the Fed likely use to implement this change? If the government increase money supply when expectations of inflation are low, they may be able to reduce the real value of government debt. Both are implications of the rational expectations hypothesis, which assumes that individuals form expectations about the future based on the information available to them, and that they act on those expectations. I is true in the short run and II is true in the long run. How do unexpected increases in monetary growth affect interest rates in the short run? Substantially increase their purchases of Treasury securities. The __________ lag is typically longer for fiscal policy than monetary policy. The average U.S. recession (after World War II) has lasted. If a central bank realizes velocity is falling sharply, what can they do to guard against declines in nominal GDP? Similarly, the expected price level at the beginning of the period is expected to hold till the end of the period. The early Phillips curve showed a tradeoff between unemployment and inflation because it was drawn for a period in which the main source of instability was aggregate demand. Rational Expectations Theory and Macroeconomic Analysis •Implications of rational expectations for macroeconomic analysis: 1.Expectations that are rational use all available information, which includes any information about government policies, such as changes in monetary or fiscal policy 2.Only new information causes expectations to change If the price level increases by more than expected, output can be expected to decrease as a result. The unemployment rate is probably above the natural rate. An expansionary fiscal policy or an easy monetary policy, designed to reduce unemployment, is correctly perceived to lead to higher prices; in consequence, private spending accelerates. an unemployment rate that is at or near the natural rate of unemployment because the actual rate of inflation will not be much different than what people expect, The tax reform of 2001, ushered through Congress by President Bush, included which of the following provisions, all above are correct; tax cuts for rich, tax cuts for poor, tax rebates, The U.S. federal budget deficit for this year is more than four times any previous deficit. Economists of the rational expectations school believe that expansionary monetary policy is fully effective only if, According to those who favor a passive approach to policy, a recessionary gap will be eliminated because. RATIONAL EXPECTATION MODEL: THE EFFECT OF EXPANSIONARY MONETARY POLICY The effect of a fully-anticipated expansion in money supply, say from M 0 to M 1 can be explained as under. This is because inflation turns out to be higher than the nominal bond yield they promise to pay. B) effective only if it is unexpected. If the monetary authorities follow policies that keep the annual rate of inflation steady and low, which of the following is most likely to occur? D) effective only when fiscal policy accommodates it. If decision makers underestimate the inflationary impact of these policies. A Senator from Arizona recently proposed lower taxes to firms that invest in new equipment. You graduate this year and start to work for $50,000. According to adaptive expectations theory, expansionary monetary and fiscal policies to reduce the unemployment rate are a. useless in the long run. The theory of rational expectations was first proposed by John F. Muth of Indiana University in the early 1960s. If the reserve requirement is 25 percent, the currency holdings of the public are unchanged, and banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be a, Income tax rates that produce revenues equal to government expenditures when an economy is at full employment. If the Federal Reserve significantly raises monetary growth (and this is unanticipated), economic theory teaches that interest rates. This means that the Euro has, appreciated, and Europeans now find U.S. goods cheaper. Real wages will fall shifting the SRAS curve to the right. If enough consumers believe that, demand eases and the good is likely to actually be less expensive next month. People respond to such rates by spending less time producing and more time protecting. Robert Emerson Lucas Jr., an American economist at the University of Chicago, who is … Suppose that the Federal Reserve significantly increases the growth rate of the money supply. This problem has been solved! Questio n 18 1 / 1 point According to the quantity theory, if constant growth in the money supply is combined with fluctuating velocity, which of the following is most likely to result? the actual rate of unemployment rises above the natural rate of unemployment, Other things constant, an increase in resource prices, Suppose Gabe Murtaugh deposits $10,000 of currency into a checking account at Wachovia Bank, M1 stays constant, but in the future M1 increases because the bank now has excess, Implications of the second Solow growth model include, both a and c (poor countries should grow faster than rich nations, rich nations only grow when technology advances), Bennett Sorbo says "The more money there is in the economy, the more people spend. according to rational expectations theory, if the gov policies in a country are anticipated, then, there is nothing gov can do, even in the short run, to reduce the ecos unemployment rate. Chapter 36 - Current Issues in Macro Theory and Policy 98. instituting a tax policy encouraging investment at the expense of consumption. According to the theory of rational expectations, this same idea can be applied to inflation forecasts. Predicting a lower rate of inflation. If the current price level is above the level anticipated when input contracts were set, the actual rate of unemployment falls below the natural rate of unemployment (u < u*), The macroeconomic theories of John Maynard Keynes provided an early explanation for. For an economy to eliminate inflation once people have begun to anticipate inflation, If an economist who favors a passive approach observes a drop in real GDP caused by a decrease in aggregate demand, she is most likely to think that, the economy will recover by itself before discretionary policy can correct the situation. 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