AP Macro MACRO: Policies and Theories 3 — Questions and Answers
Question 1: The Phillips Curve in the short run illustrates a trade-off between:
- Economic growth and trade deficits
- Inflation and unemployment (Correct answer)
- Interest rates and exchange rates
- Savings and investment
Correct answer: Inflation and unemployment
The short-run Phillips Curve shows that lower unemployment is associated with higher inflation and vice versa.
Question 2: Milton Friedman argued that the long-run Phillips Curve is vertical at the natural rate of unemployment because:
- Workers eventually adjust their inflation expectations, eliminating the trade-off (Correct answer)
- The government always intervenes to fix unemployment
- Wages are completely rigid in the long run
- Higher inflation permanently lowers the real interest rate
Correct answer: Workers eventually adjust their inflation expectations, eliminating the trade-off
Once workers adjust expectations to actual inflation, real wages return to equilibrium and unemployment returns to its natural rate.
Question 3: Which monetary policy tool is considered the Federal Reserve's primary instrument for implementing policy since the 2000s?
- Reserve requirement changes
- Discount rate adjustments
- Open market operations targeting the federal funds rate (Correct answer)
- Quantitative easing bond purchases
Correct answer: Open market operations targeting the federal funds rate
The Fed primarily targets the federal funds rate through open market operations (buying and selling Treasury securities).
Question 4: Expansionary fiscal policy is most effective when the economy is operating:
- At full employment with high inflation
- Well below potential output with a large recessionary gap (Correct answer)
- Above potential output, causing an inflationary gap
- At the natural rate of unemployment
Correct answer: Well below potential output with a large recessionary gap
Fiscal stimulus has the greatest real effect when idle resources exist and a recessionary gap means output is below potential.
Question 5: The concept of 'automatic stabilizers' refers to:
- Central bank rules that automatically adjust interest rates
- Government programs that expand spending or cut taxes automatically during recessions without new legislation (Correct answer)
- Fixed exchange rate mechanisms that stabilize currency
- Balanced budget amendments that prevent deficits
Correct answer: Government programs that expand spending or cut taxes automatically during recessions without new legislation
Programs like unemployment insurance and progressive taxes automatically inject or withdraw spending from the economy based on economic conditions.
Question 6: According to monetarists, sustained inflation is primarily caused by:
- Supply shocks such as oil price spikes
- Excessive growth in the money supply relative to real output growth (Correct answer)
- Government budget deficits financed by bonds
- Wage-push pressures from labor unions
Correct answer: Excessive growth in the money supply relative to real output growth
Monetarists, following the quantity theory of money (MV=PQ), argue that inflation results when money supply grows faster than real output.
Question 7: A central bank pursuing inflation targeting commits to:
- Keeping the money supply fixed regardless of economic conditions
- Maintaining a publicly announced inflation rate target and adjusting policy to achieve it (Correct answer)
- Pegging the currency to a foreign currency or gold
- Balancing the government's budget every year
Correct answer: Maintaining a publicly announced inflation rate target and adjusting policy to achieve it
Inflation targeting uses a publicly stated goal (e.g., 2%) to anchor expectations and guide monetary policy decisions.
AP Macro MACRO: Policies and Theories 3
The Phillips Curve in the short run illustrates a trade-off between: