GDP The Business Cycle 5 — Questions and Answers
Question 1: Which of the following describes 'stagflation,' and during which type of business cycle shock does it typically occur?
- Rapid GDP growth with low inflation; occurs during demand booms
- High inflation combined with high unemployment; typically caused by adverse supply shocks (Correct answer)
- Deflation with rising employment; caused by technology surges
- Zero inflation with zero growth; caused by balanced budget policies
Correct answer: High inflation combined with high unemployment; typically caused by adverse supply shocks
Stagflation combines high inflation and high unemployment, defying the usual Phillips Curve trade-off, and typically results from supply-side shocks like oil price spikes.
Question 2: How does the Federal Reserve typically respond during the contraction phase of the business cycle?
- It raises the federal funds rate to control inflation
- It sells Treasury securities to reduce the money supply
- It lowers the federal funds rate to stimulate borrowing and spending (Correct answer)
- It increases reserve requirements to strengthen bank capital
Correct answer: It lowers the federal funds rate to stimulate borrowing and spending
During contractions, the Fed lowers its policy rate to reduce borrowing costs, encourage investment and consumption, and stimulate recovery.
Question 3: What is the 'paradox of thrift' and how does it relate to the business cycle?
- Saving more is always good for individuals but can deepen recessions if everyone saves simultaneously (Correct answer)
- Thrift leads to investment which always accelerates recovery
- The government should save during recessions to reduce debt
- Higher savings rates always reduce the amplitude of business cycles
Correct answer: Saving more is always good for individuals but can deepen recessions if everyone saves simultaneously
The paradox of thrift, identified by Keynes, holds that while individual saving is rational, if all households save simultaneously during a downturn, aggregate demand collapses and the recession worsens.
Question 4: Which of the following would be considered a 'coincident' economic indicator, moving roughly in sync with the business cycle?
- Building permits issued
- Average duration of unemployment
- Employees on nonagricultural payrolls (Correct answer)
- Average prime lending rate
Correct answer: Employees on nonagricultural payrolls
Nonfarm payrolls is a coincident indicator that rises and falls alongside the business cycle, reflecting current economic conditions.
Question 5: During an economic expansion, why might the Federal Reserve raise interest rates even while GDP is still growing?
- To slow growth and prevent the economy from overheating with excessive inflation (Correct answer)
- To increase the value of the US dollar to boost imports
- To reduce the national debt by earning interest on reserves
- To signal confidence that a recession is imminent
Correct answer: To slow growth and prevent the economy from overheating with excessive inflation
Pre-emptive rate hikes during expansions aim to cool an overheating economy, prevent demand-pull inflation from accelerating, and extend the cycle by avoiding an abrupt peak.
Question 6: What distinguishes a 'depression' from a 'recession' in business cycle analysis?
- A depression is defined as exactly four consecutive quarters of negative GDP growth
- A depression is a more severe and prolonged economic contraction than a recession (Correct answer)
- A depression only occurs when government debt exceeds 100% of GDP
- A depression is an official NBER designation applied when unemployment exceeds 15%
Correct answer: A depression is a more severe and prolonged economic contraction than a recession
While no fixed official threshold separates them, a depression is generally understood as a far more severe, widespread, and lasting contraction than a typical recession.
Question 7: Which of the following best explains why GDP growth can remain positive even as the economy moves toward a cyclical peak?
- GDP always falls before unemployment rises, creating a lag
- Positive growth can coexist with slowing momentum as the expansion matures and approaches its peak (Correct answer)
- Peak GDP by definition is the quarter with the fastest growth rate
- GDP only turns negative after the trough is officially declared
Correct answer: Positive growth can coexist with slowing momentum as the expansion matures and approaches its peak
A business cycle peak occurs when growth rate slows to zero and reverses, so GDP can still be positive and even high right up until the contraction begins.
GDP The Business Cycle 5
Which of the following describes 'stagflation,' and during which type of business cycle shock does it typically occur?