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Chapter 27

Rational Expectations: Theory and Policy Implications


D1Factual
1. If inflationary expectations are based on all available information, they are referred to as A) optimal. B) rational. C) adaptive. D) informed. Answer: B

D1Factual
. !he primary incentive for economic a"ents to form#late expectations rationally is to A) increase earnin"s. B) increase prices. C) red#ce prices. D) ens#re that all expectations are reali$ed. Answer: A

D1Factual
%. &conomic a"ents have an incentive to form#late expectations rationally A) beca#se i"norin" information is #s#ally costly. B) to increase prices. C) to red#ce wa"es. D) to ens#re that all expectations are reali$ed. Answer: A

D1Factual
'. If an inflation forecast is based on last year(s inflation rate, it is said to be A) historical. B) rational. C) lo"ical. D) adaptive. Answer: D

88

89)itter*+ilber*,dell Money, Banking, and Financial Markets , &leventh &dition

D1Factual
-. If an inflation forecast is based on expected monetary "rowth, it is li.ely to be A) historical. B) rational. C) lo"ical. D) adaptive. Answer: B

D1Factual
/. Adaptive inflationary expectations are based on A) monetary "rowth. B) all available information. C) previo#s inflation rates. D) price chan"es in f#t#res mar.ets. Answer: C

D2Interpretive
0. If interest rates have been increasin", adaptive expectations wo#ld predict A) that interest rates will increase. B) that interest rates will decrease. C) that inflation rates will increase. D) that inflation rates will decrease. Answer: A

D1Factual
1. 2hich of the followin" wo#ld be incl#ded in inflationary expectations that are formed adaptively3 A) 4oney s#pply "rowth over the past two years B) +tatements made by the 5resident of the ,nited +tates C) !he avera"e inflation rate over the past three years D) A recent price a"reement by oil exportin" nations Answer: C

D2Interpretive
6. If the consens#s in sec#rities mar.ets is that a previo#s increase in the money s#pply will be inflationary, the li.ely res#lt will be A) hi"her real interest rates. B) hi"her nominal interest rates. C) lower real interest rates. D) lower nominal interest rates. Answer: B

Chapter 0)ational &xpectations: !heory and 5olicy Implications 90

D2Interpretive
17. If participants in sec#rities mar.ets believe that an anno#nced decrease in the money s#pply will red#ce the rate of inflation, the li.ely res#lt will be A) hi"her real interest rates. B) hi"her nominal interest rates. C) lower real interest rates. D) lower nominal interest rates. Answer: D

D2Interpretive
11. If wa"es and prices are flexible and expectations are formed rationally, an increase in the money s#pply will ca#se A) real wa"es to rise. B) real wa"es to fall. C) nominal wa"es to rise. D) nominal wa"es to fall. Answer: C

D2Interpretive
1 . )eal wa"es will decline if A) money s#pply "rowth exceeds expectations. B) real interest rates rise. C) a""re"ate demand exceeds a""re"ate s#pply. D) money s#pply "rowth exceeds the inflation rate. Answer: A

D2Interpretive
1%. )eal wa"es will rise if A) money s#pply "rowth is less than expectations. B) real interest rates fall. C) a""re"ate demand is less than a""re"ate s#pply. D) money s#pply "rowth exceeds the inflation rate. Answer: A

D2Interpretive
1'. If wa"es and prices are flexible, an anticipated chan"e in the money s#pply has no effect on A) money demand. B) nominal interest rates. C) real 8D5. D) the inflation rate. Answer: C

91)itter*+ilber*,dell Money, Banking, and Financial Markets , &leventh &dition

D1Factual
1-. An anticipated chan"e in the money s#pply will res#lt in a9n) :::::::::::::::::: level of economic activity and a :::::::::::::::::: price level. A) increased; hi"her B) decreased; hi"her C) #nchan"ed; lower D) #nchan"ed; hi"her Answer: D

D2Interpretive
1/. If wa"es and prices are flexible, then an anticipated chan"e in the money s#pply will ca#se wa"es and prices to :::::::::::::::::: the act#al inflation rate. A) increase at the same rate as B) increase at a hi"her rate than C) increase at a slower rate than D) cannot be exactly predicted Answer: A

D2Interpretive
10. As lon" as wa"es and prices are flexible, an anticipated chan"e in the money s#pply will lead to an increase in A) the #nemployment rate. B) ind#strial prod#ction. C) nominal income. D) real wa"es. Answer: C

D2Interpretive
11. Ass#min" rational expectations and complete wa"e and price flexibility, systematic stabili$ation policy impacts A) real 8D5. B) real wa"es. C) the #nemployment rate. D) the inflation rate. Answer: D

D2Interpretive
16. 2hich of the followin" expresses a similarity between 4onetarist and <ew Classical models3 A) =elocity is constant. B) 2a"es are more flexible than prices. C) )eal variables are stable in the short r#n. D) 4oney is ne#tral in the short r#n. Answer: C

Chapter 0)ational &xpectations: !heory and 5olicy Implications 92

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7. !he <ew Classical school of tho#"ht tends to have the most in common with the A) Classical economists. B) 4onetarists. C) >eynesians. D) s#pply side theorists. Answer: A

D2Interpretive
1. Contract#al inflexibility is most li.ely to slow price ad?#stment in the A) money mar.et. B) capital mar.et. C) real estate mar.et. D) labor mar.et. Answer: D

D2Factual
. >eynesians ar"#e that chan"es in wa"es will la" price level chan"es even if expectations are formed rationally beca#se A) wor.ers have very little bar"ainin" power compared with that of mana"ement. B) only a small percenta"e of wor.ers are #nioni$ed. C) wa"es are often set by lon"@term contracts. D) wor.ers often have incorrect information. Answer: C

D2Interpretive
%. Accordin" to rational expectations, A) the Aed sho#ld foc#s its policies on interest rates. B) the Aed sho#ld foc#s its policies on inflation. C) the Aed sho#ld foc#s its policies on #nemployment. D) the Aed is #nable to infl#ence real economic activity. Answer: D

D2Interpretive
'. If labor contracts prevent wa"e flexibility, the a""re"ate s#pply c#rve will be A) vertical. B) hori$ontal. C) ne"atively sloped. D) positively sloped. Answer: D

D2Interpretive
-. !he ass#mption that wa"es ad?#st more slowly than prices implies that the 5hillips C#rve A) exists in the short@r#n. B) exists in the lon"@r#n. C) is vertical. D) does not exist. Answer: A

93)itter*+ilber*,dell Money, Banking, and Financial Markets , &leventh &dition

D2Interpretive
/. If expectations are formed rationally and wa"es are inflexible in the short r#n, the short@r#n a""re"ate s#pply c#rve is A) #pward slopin". B) hori$ontal. C) vertical. D) relatively flat. Answer: C

D2Interpretive
0. If expectations are formed rationally and wa"es are flexible, the a""re"ate s#pply c#rve is A) #pward slopin". B) hori$ontal. C) vertical. D) relatively flat. Answer: C

D2Interpretive
1. In the <ew Classical macroeconomics, the de facto short@r#n a""re"ate s#pply c#rve is vertical beca#se the A) a""re"ate demand c#rve is also vertical. B) a""re"ate demand c#rve is hori$ontal. C) a""re"ate demand and a""re"ate s#pply c#rves shift sim#ltaneo#sly. D) a""re"ate demand c#rve is stable. Answer: C

D2Applied
6. An economist wor.in" with a <ew Classical model is li.ely to recommend an anti@inflation policy that foc#ses on A) increasin" the personal income tax rate. B) red#cin" the level of "overnment spendin". C) red#cin" the real rate of interest. D) a p#blicly anno#nced red#ction in the rate of monetary "rowth. Answer: D

D3Applied
%7. +earchin" for a means of temporarily red#cin" the #nemployment rate, an economist wor.in" with a <ew Classical model is li.ely to recommend an A) #nanno#nced decrease in the money s#pply. B) anno#nced decrease in the money s#pply. C) anno#nced increase in the money s#pply. D) #nanno#nced increase in the money s#pply. Answer: D

Chapter 0)ational &xpectations: !heory and 5olicy Implications 94

D2Interpretive
%1. A contractionary monetary policy can red#ce the inflation rate witho#t ca#sin" a rise in #nemployment if expectations are formed rationally and monetary policy is A) combined with expansionary fiscal policy. B) carried o#t in total secrecy. C) p#blicly anno#nced and credible. D) combined with contractionary fiscal policy. Answer: C

D2Interpretive
% . A contractionary monetary policy can red#ce real 8D5 if expectations are formed rationally and monetary policy is A) combined with expansionary fiscal policy. B) carried o#t in total secrecy. C) p#blicly anno#nced and credible. D) combined with contractionary fiscal policy. Answer: B

D2Interpretive
%%. An effective way to restore credibility to monetary a#thorities after a period of hyperinflation is A) the introd#ction of a new monetary #nit. B) the introd#ction of wa"e and price controls. C) a red#ction in ban. reserve reB#irements. D) the centrali$ation of monetary and fiscal policy #nder a sin"le "overnmental #nit. Answer: A

D2Interpretive
%'. In a <ew Classical model, hi"her nominal interest rates are ca#sed by an A) anticipated increase in the money s#pply. B) #nanticipated increase in the money s#pply. C) anticipated decrease in the money s#pply. D) #nanticipated decrease in the money s#pply. Answer: A

D2Interpretive
%-. In a <ew Classical model, monetary policy can infl#ence the real interest rate only if it is A) f#lly anticipated. B) not systematic. C) #sed with fiscal policy. D) .nown by all mar.et participants. Answer: B

95)itter*+ilber*,dell Money, Banking, and Financial Markets , &leventh &dition

D2Interpretive
%/. In a <ew Classical model, a f#lly anticipated increase in the money s#pply leads to A) no liB#idity effect. B) a lon"@term liB#idity effect. C) a positive liB#idity effect. D) a ne"ative liB#idity effect. Answer: A

D1Factual
%0. Adaptive expectations are C::::::::::::::::::D accordin" to the <ew Classical economists beca#se they :::::::::::::::::: information it is possible to #se in ma.in" a forecast. A) rational; incl#de all B) rational; excl#de some C) irrational; incl#de all D) irrational; excl#de some Answer: D

D2Factual
%1. &xtrapolatin" past val#es of a variable to the present is the practice of :::::::::::::::::: expectations, which is fairly common amon" :::::::::::::::::: economists. A) adaptive; <ew Classical B) adaptive; >eynesian C) rational; <ew Classical D) rational; >eynesian Answer: B

D1Interpretive
%6. A ri"htward shift of a""re"ate demand will raise o#tp#t only if A) wa"es remain #nchan"ed. B) wa"es rise by a lower percenta"e than prices. C) wa"es rise by the same percenta"e as prices. D) wa"es rise by a "reater percenta"e than prices. Answer: B

D2Factual
'7. An #nanno#nced increase in the money s#pply will increase both prices and real 8D5 #nder A) neither rational nor adaptive expectations. B) rational b#t not adaptive expectations. C) adaptive b#t not rational expectations. D) both adaptive and rational expectations. Answer: D

Chapter 0)ational &xpectations: !heory and 5olicy Implications 96

D3Interpretive
'1. +#ppose that for several periods the a""re"ate demand and s#pply c#rves have been intersectin" at the same point, and at f#ll employment. !hen the central ban. increases money "rowth as a res#lt of an anno#nced policy chan"e. ,nder the ass#mption of adaptive expectations the li.ely short@r#n res#lt is :::::::::::::::::: o#tp#t and :::::::::::::::::: price level. A) risin"; a risin" B) risin"; an #nchan"ed C) #nchan"ed; a risin" D) #nchan"ed; an #nchan"ed Answer: A

D3Interpretive
' . +#ppose that for several periods the a""re"ate demand and s#pply c#rves have been intersectin" at the same point, and at f#ll employment. !he central ban. increases money "rowth as a res#lt of an #nanno#nced policy chan"e. ,nder the ass#mption of adaptive expectations the li.ely short@r#n res#lt is :::::::::::::::::: o#tp#t and :::::::::::::::::: price level. A) risin"; a risin" B) risin"; an #nchan"ed C) #nchan"ed; a risin" D) #nchan"ed; an #nchan"ed Answer: A

D3Interpretive
'%. +#ppose that for several periods the a""re"ate demand and s#pply c#rves have been intersectin" at the same point, and at f#ll employment. !hen the central ban. increases money "rowth as the res#lt of an anno#nced policy chan"e. ,nder <ew Classical ass#mptions the li.ely short@r#n res#lt is :::::::::::::::::: o#tp#t and :::::::::::::::::: price level. A) risin"; a risin" B) risin"; an #nchan"ed C) #nchan"ed; a risin" D) #nchan"ed; an #nchan"ed Answer: C

D3Interpretive
''. +#ppose that for several periods the a""re"ate demand and s#pply c#rves have been intersectin" at the same point, and at f#ll employment. !hen the central ban. increases money "rowth as the res#lt of an #nanno#nced policy chan"e. ,nder <ew Classical ass#mptions the li.ely short@r#n res#lt is :::::::::::::::::: o#tp#t and :::::::::::::::::: price level. A) risin"; a risin" B) risin"; an #nchan"ed C) #nchan"ed; a risin" D) #nchan"ed; an #nchan"ed Answer: A

97)itter*+ilber*,dell Money, Banking, and Financial Markets , &leventh &dition

D3Interpretive
'-. If wa"es do not instantaneo#sly ad?#st to reflect expected inflation that is based on an anticipated increase in the money s#pply, A) the a""re"ate demand and positively sloped a""re"ate s#pply c#rve shift to the ri"ht at the same time. B) the positively slopin" a""re"ate s#pply c#rve shifts to the left after the a""re"ate demand c#rve shifts to the ri"ht. C) the positively slopin" a""re"ate s#pply c#rve shifts to the left before the a""re"ate demand c#rve shifts to the ri"ht. D) the positively slopin" a""re"ate s#pply c#rve does not shift to the ri"ht at the same time as the a""re"ate demand c#rve shifts to the left. Answer: B

D3Interpretive
'/. If wa"es instantaneo#sly ad?#st to reflect expected inflation that is based on an anticipated increase in the money s#pply, A) the a""re"ate demand and positively sloped a""re"ate s#pply c#rve shift to the ri"ht at the same time. B) the positively slopin" a""re"ate s#pply c#rve shifts to the left after the a""re"ate demand c#rve shifts to the ri"ht. C) the positively slopin" a""re"ate s#pply c#rve shifts to the left before the a""re"ate demand c#rve shifts to the ri"ht. D) the positively slopin" a""re"ate s#pply c#rve does not shift to the ri"ht at the same time as the a""re"ate demand c#rve shifts to the left. Answer: A

D2Factual
'0. <ew Classical macroeconomics incorporates the ass#mption that wa"es are ::::::::::::::::::, so that the #pward@slopin" a""re"ate s#pply c#rve :::::::::::::::::: anticipated shifts of the a""re"ate demand c#rve. A) stic.y; shifts in response to B) stic.y; remains constant despite C) flexible; shifts in response D) flexible; remains constant despite Answer: C

D1Factual
'1. ,nder <ew Classical ass#mptions, an anticipated chan"e in the money "rowth rate chan"es A) both real o#tp#t and the inflation rate. B) real o#tp#t alone with no conseB#ences on inflation. C) inflation alon" with no conseB#ences on o#tp#t. D) neither real o#tp#t nor inflation. Answer: C

Chapter 0)ational &xpectations: !heory and 5olicy Implications 98

D1Factual
'6. ,nder <ew Classical ass#mptions, an #nanticipated chan"e in the money "rowth rate chan"es A) both real o#tp#t and the inflation rate. B) real o#tp#t alone with no conseB#ences on inflation. C) inflation alon" with no conseB#ences on o#tp#t. D) neither real o#tp#t nor inflation. Answer: A

D2Factual
-7. Can a >eynesian still believe in an active co#nter@cyclical policy if she adopts the ass#mption of rational expectations3 A) <o, it destroys the case for active policy. B) Ees, so lon" as she contin#es to ass#me wa"e and price ri"idity. C) Ees, if she also adopts the ass#mption of wa"e and price flexibility. D) Ees, if she ass#mes that economic policy shifts are anticipated in advance. Answer: B

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