Macro_30

1. The classical principle of monetary neutrality states that changes in the money supply do not influence _________ variables, and it is thought most applicable in the _________ run.

• a. nominal; short

• b. nominal; long

• c. real; short

• d. real; long

Answer explanation

• The monetary neutrality principle suggests that changes in the money supply affect only nominal variables (e.g., price level, wages, and exchange rates), but not real variables (e.g., real GDP, employment, and real wages) in the long run.

• In the short run, monetary policy can influence real output due to price and wage rigidities, but in the long run, these effects fade, and only nominal prices adjust.

2. If nominal GDP is $400, real GDP is $200, and the money supply is $100, then

• a. the price level is ½, and velocity is 2.

• b. the price level is ½, and velocity is 4.

• c. the price level is 2, and velocity is 2.

• d. the price level is 2, and velocity is 4.

3. According to the quantity theory of money, which variable in the quantity equation is most stable over long periods of time?

• a. money

• b. velocity

• c. price level

• d. output

Answer explanation

Velocity (V) is generally considered the most stable variable over the long run, because it depends on spending habits and institutional factors, which change slowly compared to money supply and price levels.

4. According to the quantity theory of money and the Fisher effect, if the central bank increases the rate of money growth, then

• a. inflation and the nominal interest rate both increase.

• b. inflation and the real interest rate both increase.

• c. the nominal interest rate and the real interest rate both increase.

• d. inflation, the real interest rate, and the nominal interest rate all increase.

5. Hyperinflation occurs when the government runs a large budget _________, which the central bank finances with a substantial monetary _________.

• a. deficit; contraction

• b. deficit; expansion

• c. surplus; contraction

• d. surplus; expansion

Answer explanation

• Hyperinflation happens when the government has a large budget deficit (spending more than it collects in revenue).

• --> To cover this deficit, the central bank often prints more money (monetary expansion), which causes rapid inflation as more money chases the same amount of goods.

6. Ongoing inflation does not automatically reduce most people’s incomes because

• a. the tax code is fully indexed for inflation.

• b. people respond to inflation by holding less money

• c. wage inflation goes together with price inflation.

• d. higher inflation lowers real interest rates.

7. If an economy always has inflation of 10 percent per year, which of the following costs of inflation will it NOT suffer?

• a. shoeleather costs from reduced holdings of money

• b. menu costs from more frequent price adjustment

• c. distortions from the taxation of nominal capital gains

• d. arbitrary redistributions between debtors and creditors

Answer explanation

Predictable inflation (like a stable 10% per year) allows businesses, lenders, and borrowers to adjust expectations when setting interest rates and wages.

Arbitrary redistributions between debtors and creditors occur when inflation is unexpected, because loans are typically agreed upon in nominal terms.

8. 8. Because most loans are written in _________ terms, an unexpected increase in inflation hurts _________.

• a. real; creditors

• b. real; debtors

• c. nominal; creditors

• d. nominal; debtors