314 section 6 Inflation, Unemployment, and Stabilization Policies
Tackle the Test: Multiple-Choice Questions
- Which of the following is a goal of monetary policy?
a. zero inflation
b. deflation
c. price stability
d. increased potential output
e. decreased actual real GDP - When implementing monetary policy, the Federal Reserve
attempts to achieve
a. an explicit target inflation rate.
b. zero inflation.
c. a low rate of deflation.
d. a low, but positive inflation rate.
e. 4–5% inflation. - At each meeting of the Federal Open Market Committee, the
Federal Reserve sets a target for which of the following?
I. the federal funds rate
II. the prime interest rate
III. the market interest rate
a. I only
b. II only
c. III only
d. I and III only
e. I, II, and III - Which of the following actions can the Fed take to decrease the
equilibrium interest rate?
a. increase the money supply
b. increase money demand
c. decrease the money supply
d. decrease money demand
e. both (a) and (d) - Contractionary monetary policy attempts to
aggregate demand by interest rates.
a. decrease increasing
b. increase decreasing
c. decrease decreasing
d. increase increasing
e. increase maintaining
Tackle the Test: Free-Response Questions
- a. Give the equation for the Taylor rule.
b. How well does the Taylor rule fit the Fed’s actual behavior?
Explain.
c. What does the Taylor rule predict will happen when the
inflation rate increases? Explain.
d. What does the Taylor rule predict will happen if the
economy sinks further into a recession? Explain.
Answer (7 points)
1 point:Federal funds rate = 1 +(1.5×inflation rate) +(0.5×output gap)
1 point:Not exactly, but fairly well
1 point:It does better than any one measure alone, and it has always correctly
predicted the direction of change of interest rates.
1 point:The federal funds rate will increase.
1 point:According to the equation, the federal funds rate increases by 1.5
percentage points for every one percentage point increase in inflation. OR, the
Taylor rule predicts contractionary monetary policy during periods of inflation.
1 point:The federal funds rate will decrease.
1 point:According to the equation, the federal funds rate decreases by 0.5
percentage points for every one percentage point decrease in the output gap, as
from−1% to −2%, indicating a deeper recession. OR, the Taylor rule predicts
expansionary monetary policy during periods of recession.
- a. What can the Fed do with each of its tools to implement
expansionary monetary policy during a recession?
b. Use a correctly labeled graph of the money market to explain
how the Fed’s use of expansionary monetary policy affects
interest rates in the short run.
c. Explain how the interest rate changes you graphed in part b
affect aggregate supply and demand in the short run.
d. Use a correctly labeled aggregate demand and supply graph
to illustrate how expansionary monetary policy affects
aggregate output in the short run.