Macroeconomics Flashcards

The Taylor Rule for monetary policy suggests the Fed should raise the federal funds rate when:

Answer: Inflation exceeds target or the output gap is positive

The Taylor Rule prescribes raising rates when inflation is above target or when actual output exceeds potential output (positive output gap).

Which automatic stabilizer automatically increases government spending during a recession without new legislation?

Answer: Unemployment insurance payments

Unemployment insurance automatically pays out more during recessions as layoffs rise, stimulating demand without requiring new legislation.

In the long run, the Phillips Curve is generally considered to be:

Answer: Vertical at the natural rate of unemployment

Friedman and Phelps demonstrated that the long-run Phillips Curve is vertical at the natural rate, as workers adjust expectations and real wages return to equilibrium.

Purchasing Power Parity (PPP) theory states that in the long run, exchange rates adjust so that:

Answer: A basket of goods costs the same in all countries when measured in a common currency

PPP holds that exchange rates move to equalize the price of identical goods across countries when converted to a common currency.

An economy is at full employment. The government increases spending financed by borrowing. In the short run, this is most likely to cause:

Answer: Higher output and higher prices

Expansionary fiscal policy at full employment shifts AD right; with limited spare capacity, the result is primarily inflationary with some short-run output increase.

The concept of 'liquidity trap' refers to a situation where:

Answer: Monetary policy loses effectiveness because the nominal interest rate is near zero

In a liquidity trap, interest rates are at or near zero and people hoard money rather than invest, making further monetary expansion ineffective.

Real GDP differs from nominal GDP in that real GDP:

Answer: Is adjusted for changes in the price level using a base-year price index

Real GDP removes the effect of price level changes by valuing output at constant (base-year) prices, allowing comparisons of actual production over time.