econ chap 17

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

• 
  a. real; long

• b. nominal; short

  
  

• c. real; short

  
  

• d. nominal; long

  
  

Answer explanation

• - monetary neutrality: the proposition that changes in the money supply do not affect real variables

• - When studying long-run changes in the economy, the neutrality of money offers a reasonably good description of how the world works.

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 2, and velocity is 4

  
  

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

  
  

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

Answer explanation

money supply x velocity = price level x output/real GDP (MV = PY)

• - price level = GDP deflator

• - velocity of money = nominal value of output(nominal GDP)/quantity of money

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

• a. Output

• b. Velocity

• c. Price level

  
  

• d. Money

  
  

Answer explanation

In many cases, it turns out that the velocity of money is relatively stable, at least compared with other economic variables

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

• a. surplus; contraction

• 
  b. deficit; contraction

  
  

• c. deficit; expansion

  
  

• d. surplus; expansion

Answer explanation

the governments of these countries are using money creation to pay for their spending

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 real interest rate both increase

• b. inflation and the nominal 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

Answer explanation

• - the quantity theory of money: a theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate

• - the Fisher effect states that the nominal interest rate adjusts to expected inflation. Expected inflation moves with actual inflation in the long run but not necessarily in the short run.

Ongoing inflation does not automatically reduce most people's incomes because ________.

• a. people respond to inflation by holding less money

• b. wage inflation goes together with price inflation

  
  

• c. higher inflation lowers real interest rates

• d. the tax code is fully indexed for inflation

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

• a. Distortions from the taxation of nominal capital gains

• b. Shoeleather costs from reduced holdings of money

  
  

• c. Menu costs from more frequent price adjustment

• 
  d. Arbitrary redistributions between debtors and creditors

Answer explanation

Since arbitrary redistributions occur only when inflation is unexpected, this cost disappears when inflation is perfectly predictable.

Why the others still happen:

a. Distortions from taxation of nominal capital gains
Still occurs because taxes are based on nominal, not real, gains.

b. Shoeleather costs
Still occurs because people reduce money holdings to avoid losing purchasing power.

c. Menu costs
Still occurs because firms must frequently change prices to keep up with inflation.

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

• 
  a. nominal; creditors

• b. nominal; debtors

  
  

• c. real; creditors

• d. real; debtors

Substantial or persistent inflation is caused by _______.

• 
  a. banks that have market power and refuse to lend money

  
  

• b. governments that raise taxes so high that it increases the cost of doing business and, hence, raises prices

• c. governments that print too much money

  
  

• d. increases in the price of inputs, such as labor and oil

When prices rise at an extraordinarily high rate, it is called _______.

• a. hyperinflation

• b. deflation

• c. hypoinflation

  
  

• d. disinflation

  
  

• e. inflation