Mishkin 6ce TB Ch25

Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 25 The Role of Expectations in Monetary Policy
25.1 Lucas Critique of Policy Evaluation
1) Today, most economists ________.

A) accept that expectations formation will change when the behavior of forecasted variables
changes
B) believe that the Lucas critique has been discredited
C) accept the notion that there is no role for discretionary stabilization policy
D) believe that having policy credibility is not an important factor to a successful anti-inflation
policy
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 25.1 Summarize the Lucas critique
2) Whether one views the discretionary policies of the 1960s and 1970s as destabilizing or
believes the economy would have been less stable without these policies, most economists
agree that ________.
A) stabilization policies proved more difficult in practice than many economists had expected
B) stabilization policies proved not to be inflationary
C) the nondiscretionary policymakers were right in believing that the private economy is
inherently stable
D) the discretionary policymakers were right in believing that the private economy is inherently
stable
Answer: A
Diff: 2 Type: MC
Skill: Recall
3) The argument that econometric policy evaluation is likely to be misleading if policymakers

assume stable economic relationships is known as ________.
A) the monetarist revolution
B) the Lucas critique
C) public choice theory
D) new Keynesian theory
Answer: B
Diff: 2 Type: MC
Skill: Recall
1
Copyright 2017 Pearson Canada, Inc.
4) Lucas argues that when policies change, expectations will change thereby ________.
A) changing the relationships in econometric models
B) causing the government to abandon its discretionary stance
C) forcing the Fed to keep its deliberations secret
D) making it easier to predict the effects of policy changes
Answer: A
Diff: 2 Type: MC
Skill: Recall
5) The rational expectations hypothesis implies that when macroeconomic policy changes,
________.
A) the economy will become highly unstable
B) the way expectations are formed will change
C) people will be slow to catch on to the change
D) people will make systematic mistakes
Answer: B
Diff: 2 Type: MC
Skill: Recall
6) The Lucas critique indicates that ________.

A) advocates of discretionary policies' criticisms of rational expectations models are well-
founded
B) advocates of discretionary policies' criticisms of rational expectations models are not well-
founded
C) expectations are important in determining the outcome of a discretionary policy
D) expectations are not important in determining the outcome of a discretionary policy
Answer: C
Diff: 2 Type: MC
Skill: Recall
7) The Lucas critique is an attack on the usefulness of ________.

A) conventional econometric models as forecasting tools
B) conventional econometric models as indicators of the potential impacts on the economy of
particular policies
C) rational expectations models of macroeconomic activity
D) the relationship between the quantity theory of money and aggregate demand
Answer: B
Diff: 2 Type: MC
Skill: Recall
2
8) The interest rate thought to have the most important impact on aggregate demand is the
________.
A) short-term interest rate
B) T-bill rate
C) rate on 90-day CDs
D) long-term interest rate
Answer: D
Diff: 2 Type: MC
Skill: Recall
9) A rise in short-term interest rates that is believed to be only temporary ________.

A) is likely to have a significant effect on long-term interest rates
B) will have a bigger impact on long-term interest rates than if the rise in short-term rates had
been permanent
C) is likely to have only a small impact on long-term interest rates
D) cannot possibly affect long-term interest rates
Answer: C
Diff: 2 Type: MC
Skill: Recall
10) According to the Lucas critique, if past increases in the short-term interest rate have always
been temporary, then ________.
A) the term-structure relationship using past data will then show only a weak effect of changes
in the short-term interest rate on the long-term rate
B) the term-structure relationship using past data will show no effect of changes in the short-
term interest rate on the long-term rate
C) one cannot predict the term-structure relationship as it depends on expectations
D) the term-structure relationship using past data will nevertheless show a strong effect of
changes in the short-term interest rate on the long-term rate because of a change in the way
expectations are formed
Answer: A
Diff: 2 Type: MC
Skill: Recall
3
25.2 Policy Conduct: Rules or Discretion
1) A policy in which the money supply is kept growing at a constant rate regardless of the state
of the economy is ________.
A) a Taylor rule
B) a discretionary policy
C) a policy rule advocated by monetarists
D) advocated by activists
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 25.2 Compare and contrast the use of policy rules versus discretionary policy
2) The Lucas critique highlighted the need for ________.

A) better econometric models
B) new policy models that included rational expectations
C) fiscal policy
D) adaptive expectations
Answer: A
Diff: 2 Type: MC
Skill: Recall
3) Operating with discretion in a monetary policy sense implies ________.

A) making no commitment to future actions
B) a constant growth rate rule
C) introducing a zero inflation rule
D) making decisions without regulatory oversight
Answer: A
Diff: 2 Type: MC
Skill: Recall
4) The time inconsistency problem with respect to policy conduct means ________.
A) the tendency to deviate from long-run plans when making short run decisions
B) implementing a constant growth rate rule
C) that politicians are not elected for long enough time frames
D) there is no room for hard and fast monetary rules
Answer: A
Diff: 2 Type: MC
Skill: Recall
4
5) The time inconsistency problem means that policy makers are always tempted to pursue
________ policy in the short run.
A) expansionary
B) contractionary
C) inconsistent
D) non-discretionary
Answer: A
Diff: 2 Type: MC
Skill: Recall
6) The best way to keep inflation under control is to ________.

A) abandon discretionary policy
B) abandon expansionary policy
C) invoke activist solutions
D) A and B only
Answer: A
Diff: 2 Type: MC
Skill: Recall
7) The opposite of a discretionary approach is a ________ approach.

A) rules based
B) activist
C) non-activist
D) Keynesian
Answer: A
Diff: 2 Type: MC
Skill: Recall
8) Milton Friedman and his followers are known as ________.

A) monetarists
B) activists
C) Keynesians
D) neo-Keynesians
Answer: A
Diff: 2 Type: MC
Skill: Recall
5
9) A rule that is advocated by the monetarists is the ________ rule.
A) constant money growth rate
B) escalating money growth rate
C) fiscal expansionism
D) interest rate sterilization
Answer: A
Diff: 2 Type: MC
Skill: Recall
10) An example of a rule used in non-discretionary monetary policy is ________.

A) the Taylor rule
B) the Taylor principle
C) Keynesian rule
D) interest rate consistency
Answer: A
Diff: 2 Type: MC
Skill: Recall
11) One example where a rules based approach would have improved the economy is
________.
A) the Great Depression
B) the financial crisis in 2007
C) the subprime mortgage markets
D) derivatives trading
Answer: A
Diff: 2 Type: MC
Skill: Recall
12) The political business cycle can lead to ________.

A) expansionary monetary policy
B) expansionary fiscal policy
C) corruption
D) A and B only
Answer: D
Diff: 2 Type: MC
Skill: Recall
6
13) The Lucas critique indicates that ________.
A) Keynesian criticisms of rational expectations models are well-founded
B) Keynesian criticisms of rational expectations models are not well-founded
C) expectations are important in determining the outcome of an activist policy
D) expectations are not important in determining the outcome of an activist policy
Answer: C
Diff: 2 Type: MC
Skill: Recall
14) One of the drawbacks of rules based monetary policy is ________.

A) it can be too rigid a system and unable to address unforeseen contingencies
B) it minimizes the role of central banks and bankers
C) these types of programs are difficult to implement in practice
D) none of the above
Answer: A
Diff: 2 Type: MC
Skill: Recall

A) they do not incorporate the judgment of monetary policy makers
B) they are too complicated for the general public to understand
Answer: A
Diff: 2 Type: MC
Skill: Recall

A) the true model of the economy is unknown, so a single rule may not be appropriate
Answer: A
Diff: 2 Type: MC
Skill: Recall
7
A) the current relationship between variables may not hold in the future
Answer: A
Diff: 2 Type: MC
Skill: Recall

A) it is subject to the Lucas critique
Answer: A
Diff: 2 Type: MC
Skill: Recall
19) Monetarists argue that the Bank of Canada should pursue ________.
A) an interest-rate targeting strategy
B) an exchange-rate targeting strategy
C) a discretionary monetary policy
D) a constant growth rate rule
Answer: D
Diff: 2 Type: MC
Skill: Recall
20) If aggregate output is below the natural rate level, advocates of nondiscretionary policy
would recommend that the government ________.
A) do nothing
B) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to
the right
C) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the right
D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the left
Answer: A
Diff: 2 Type: MC
Skill: Recall
8
21) Advocates of nondiscretionary policy contend that a discretionary policy of shifting the
aggregate ________ curve will be costly because it produces ________ volatility in both the
price level and output.
A) supply; less
B) supply; more
C) demand; less
D) demand; more
Answer: D
Diff: 2 Type: MC
Skill: Recall
22) Some economists contend that a policy of shifting the aggregate demand curve will be
costly because it produces more volatility in both the price level and output. These economists
likely are advocates of ________ policy.
A) supply-side
B) discretionary
C) demand-management
D) nondiscretionary
Answer: D
Diff: 2 Type: MC
Skill: Recall
23) The existence of lags prevents the instantaneous adjustment of the economy to policies
changing aggregate demand, thereby strengthening the case for ________ policy.
A) supply-side
B) nondiscretionary
C) discretionary
D) demand-management
Answer: B
Diff: 2 Type: MC
Skill: Recall
9
24) Which of the following views are consistent with the case for nondiscretionary
macroeconomic policy?
A) Even with time lags, discretionary policy moves the economy to full employment before the
economy's self-correcting mechanism would.
B) The wage and price adjustment process being extremely slow, a nondiscretionary policy
results in a large loss of output.
C) Workers will come to expect expansionary policies whenever the economy moves below
full employment.
D) A discretionary, accommodating policy of shifting the aggregate demand curve will produce
less volatility in both the price level and output due to the short time it takes to shift aggregate
demand.
Answer: C
Diff: 2 Type: MC
Skill: Recall
25) If expectations about policy affect how wages are set, then the case for a(n) ________
policy is much stronger.
A) discretionary
B) nondiscretionary
C) interventionist
D) stabilization
Answer: B
Diff: 2 Type: MC
Skill: Recall
26) Evidence indicating that the wage and price adjustment process is extremely slow would
strengthen the case for ________.
A) nondiscretionary policy
B) a constant-money-growth-rate rule
C) discretionary policy
D) None of the above
Answer: C
Diff: 2 Type: MC
Skill: Recall
10
27) Advocates of nondiscretionary policy emphasize the importance of a constant money
growth rate rule more than the balanced-budget amendment or restrictions on union power
because ________.
A) they regard excessive money growth as the cause of inflation
B) they believe that excessive government spending, not excessive monetary growth, is the
cause of inflation
C) they believe that while unions cause inflation, they are too politically powerful to deal with
D) they regard high tax rates as the cause of inflation
Answer: A
Diff: 2 Type: MC
Skill: Recall
28) Advocates of nondiscretionary policy contend that a policy of shifting the aggregate
demand curve will be costly because it produces more volatility in both the price level and
output. Thus they favor ________.
A) a policy of variable money supply growth
B) supply-side policy
C) demand-management policy
D) a constant-money-growth-rate rule
Answer: D
Diff: 2 Type: MC
Skill: Recall
29) A credible, nonaccommodating policy rule has the ________ that it makes a cost-push by
workers ________ likely and thus helps to reduce the output loss from controlling inflation.
A) advantage; less
B) advantage; more
C) disadvantage; less
D) disadvantage; more
Answer: A
Diff: 2 Type: MC
Skill: Recall
30) Monetarists contend that ________.

A) the self-correcting mechanism works slowly because wages are inflexible
B) the aggregate supply curve does not move quickly to restore the economy to the natural rate
of unemployment
C) active government policy is required to restore the economy to full employment when
unemployment is high
D) the Bank of Canada should adopt and follow a money growth rule
Answer: D
Diff: 2 Type: MC
Skill: Recall
11
31) Monetarists ________.
A) see wages as being sufficiently sticky so that the wage and price adjustment process is
reasonably slow
B) are skeptical of the need for active government policies to restore the economy to full
employment
C) argue for active government policy to restore the economy to full employment when
unemployment is high
D) A and B only
Answer: B
Diff: 2 Type: MC
Skill: Recall
32) Monetarists believe all of the following except that ________.

A) active government policies are required to restore the economy to full employment
B) the Bank of Canada should adopt and follow a money growth rule
C) the self-correcting mechanism works quickly because wages are sufficiently flexible
D) the aggregate supply curve shifts quickly to restore the economy to the natural rate of
unemployment
Answer: A
Diff: 2 Type: MC
Skill: Recall
33) Arguments for adopting a policy rule include ________.

A) the time-inconsistency problem can lead to poor economic outcomes
B) discretionary policies pursue overly expansionary monetary policies to boost employment in
the short run but generate higher inflation in the long run
C) policy makers and politicians cannot be trusted
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
12
34) Arguments for adopting a policy rule include ________.
A) discretion avoids the straightjacket that would lock in the wrong policy if the model that was
used to derive the policy rule proved to be incorrect
B) discretion enables policy makers to change policy settings when an economy undergoes
structural changes
C) discretionary policies pursue overly expansionary monetary policies to boost employment in
D) all of the above
Answer: C
Diff: 2 Type: MC
Skill: Recall
35) Arguments for discretionary policies include ________.

A) policy rules can be too rigid because they cannot foresee every contingency
B) the time-inconsistency problem can lead to poor economic outcomes
C) discretionary policies pursue overly expansionary monetary policies to boost employment in
D) all of the above
Answer: A
Diff: 2 Type: MC
Skill: Recall
36) Arguments for discretionary policies include ________.

A) policy rules can be too rigid because they cannot foresee every contingency
B) policy rules do not easily incorporate the use of judgment
C) discretion avoids the straightjacket that would lock in the wrong policy if the model that was
used to derive the policy rule proved to be incorrect
D) discretion enables policy makers to change policy settings when an economy undergoes
structural changes
E) all of the above
Answer: E
Diff: 2 Type: MC
Skill: Recall
37) ________ imposes a conceptual structure and inherent discipline on policy makers, but
without eliminating all flexibility.
A) Constrained discretion
B) A policy rule
C) A discretionary policy
D) The Taylor rule
Answer: A
Diff: 2 Type: MC
Skill: Recall
13
38) Describe discretionary and nondiscretionary policy in the case of a negative aggregate
supply shock to the economy. Use a graph to support your answer.
Answer: When the economy moves from point 1 to 1' after a supply shock then policymakers
have two choices: The nondiscretionary policy of doing nothing and letting the aggregate
supply curve to move back to the original position, or the discretionary policy and try to shift
the aggregate demand curve to move the economy to point 2.
Case for a discretionary policy: if the wages and prices adjust extremely slow a
nondiscretionary policy is considered by an advocate for discretionarys as costly because the
slow movement of the economy back to full employment results in a large loss of output.
Case for a nondiscretionary policy: advocates for nondiscretionary policy view the wage and
price adjustment process as more rapid than advocates for discretionary do and consider
nondiscretionary policy less costly because output is soon back at the natural rate level. They
suggest that an discretionary accommodating policy of shifting the aggregate demand curve to
AD2 is costly because it produces more volatility in both the price level and output.
Diff: 2 Type: ES
Skill: Recall
14
25.3 The Role of Credibility and a Nominal Anchor
1) A credible nominal anchor ________.

A) can help overcome the time-inconsistency problem by providing an expected constraint on
discretionary policy
B) can help to anchor inflation expectations, which leads to smaller fluctuations in inflation
C) is required for a policy rule
D) all of the above
E) A and B only
Answer: E
Diff: 2 Type: MC
Skill: Recall
Objective: 25.3 Summarize and illustrate the benefits of a credible central bank
2) Suppose that there is a positive aggregate demand shock and the central bank commits to an
inflation rate target. If the commitment is credible, then ________.
A) the public's expected inflation will remain unchanged
B) the short-run aggregate supply curve will not shift
C) over time inflation will fall back down to the inflation target
D) all of the above
E) A and B only
Answer: D
Diff: 2 Type: MC
Skill: Recall
3) Suppose that there is a positive aggregate demand shock and the central bank commits to an
inflation rate target. But if the commitment is not credible, then ________.
B) the short-run aggregate supply curve will rise
C) over time inflation will fall back down to the inflation target
D) all of the above
E) A and B only
Answer: B
Diff: 2 Type: MC
Skill: Recall
15
4) Suppose that there is a negative aggregate demand shock and the central bank commits to an
inflation rate target. If the commitment is credible, then ________.
C) over time inflation will fall
D) all of the above
E) A and C only
Answer: A
Diff: 2 Type: MC
Skill: Recall
5) Suppose that there is a negative aggregate demand shock and the central bank commits to an
inflation rate target. But if the commitment is not credible, then ________.
C) economic contraction will be worse
D) all of the above
E) B and C only
Answer: E
Diff: 2 Type: MC
Skill: Recall
6) Suppose that there is a negative aggregate supply shock and the central bank commits to an
inflation rate target.
A) If the commitment is credible, the public's expected inflation will remain unchanged.
B) Credible policy produces better outcomes on both inflation and output in the short run.
C) Policies that are not credible produce worse economic contraction.
D) all of the above.
E) A and C only.
Answer: D
Diff: 2 Type: MC
Skill: Recall
7) The U.S. government can play an important role in establishing the credibility of anti-
inflation policy by ________.
A) demonstrating fiscal responsibility
B) monitoring the Fed
C) conducting fiscal policy
D) all of the above
Answer: A
Diff: 2 Type: MC
Skill: Recall
16
8) If aggregate output is below the natural rate level, advocates of discretionary policy would
recommend that the government ________.
A) do nothing
B) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to
the right
C) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the right
D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the left
Answer: C
Diff: 2 Type: MC
Skill: Recall
9) When expectations of inflation are formed rationally, an anti-inflationary policy will be more
successful if it is ________.
A) credible
B) a surprise
C) unanticipated
D) announced
Answer: A
Diff: 2 Type: MC
Skill: Recall
10) It may be necessary to cut the deficit as part of a credible anti-inflationary policy because
the public knows that large deficits ________.
A) are inflationary by themselves in the long run
B) create inefficiencies
C) put pressure on the Bank of Canada to expand the money supply to keep interest rates from
rising
D) put pressure on the Bank of Canada to contract the money supply to prevent employment
from rising
Answer: C
Diff: 2 Type: MC
Skill: Recall
11) By ________ its deficit, the government's credibility of anti-inflationary policy ________.
A) not changing; remains the same
B) reducing; increases
C) reducing; decreases
D) not changing; increases
Answer: B
Diff: 2 Type: MC
Skill: Recall
17
12) By ________ its deficit, the government makes an anti-inflationary policy ________
credible.
A) increasing; more
B) reducing; more
C) reducing; less
D) not changing; more
Answer: B
Diff: 2 Type: MC
Skill: Recall
13) An example of a nominal anchor is ________.

A) the inflation rate
B) the real interest rate
C) government purchases
D) the tax rate
Answer: A
Diff: 2 Type: MC
Skill: Recall
14) The benefits of a credible nominal anchor include ________.

A) acting like a behaviour rule
B) preventing the real business cycle from occurring
C) encouraging activist policy
D) preventing discretion based actions
Answer: A
Diff: 2 Type: MC
Skill: Recall
15) The benefits of a credible nominal anchor include ________.

A) anchors inflation expectations
B) preventing the real business cycle from occurring
C) encouraging activist policy
D) preventing discretion based actions
Answer: A
Diff: 2 Type: MC
Skill: Recall
18
16) With a positive aggregate demand shock, monetary policy credibility can ________.
A) stabilize inflation
B) set inflation equal to zero
C) determine the effective interest rate
D) prevent financial malfeasance
Answer: A
Diff: 2 Type: MC
Skill: Recall
17) If a positive aggregate demand shock occurs and monetary policy is not credible then
________.
A) inflation will increase
B) the equilibrium interest rate will fall
C) there will be a corresponding autonomous decrease in aggregate supply
Answer: A
Diff: 2 Type: MC
Skill: Recall
18) A positive aggregate demand shock will only impact ________.

A) the equilibrium output
B) the equilibrium inflation rate
C) the short run aggregate supply curve
Answer: D
Diff: 2 Type: MC
Skill: Recall
19) An example of a positive aggregate demand shock is ________.

A) carbon cap-and-trade program
B) productivity improving technological innovation
C) an increase in the price of oil
D) the shale gas revolution
Answer: B
Diff: 2 Type: MC
Skill: Recall
19
20) The difference in outcomes occurring with a credible nominal anchor and without one,
given a positive aggregate demand shock is that ________.
A) with the credible policy there is no shift in the aggregate supply curve
B) there is no difference but credibility provides national security
C) without credible policy, inflation will continue to spiral upwards
D) with credible policy, the aggregate supply curve shifts back quickly
Answer: A
Diff: 2 Type: MC
Skill: Recall
21) With a negative aggregate demand shock, monetary policy credibility can ________.
A) stabilize output
Answer: A
Diff: 2 Type: MC
Skill: Recall
22) If a negative aggregate demand shock occurs and monetary policy is not credible then
________.
A) economic activity will decrease
B) the equilibrium interest rate will rise
C) there will be a corresponding autonomous increase in inflation
Answer: A
Diff: 2 Type: MC
Skill: Recall
23) A negative aggregate demand shock will only impact ________.

A) the equilibrium interest rate
Answer: D
Diff: 2 Type: MC
Skill: Recall
20
24) An example of a negative aggregate demand shock is ________.
A) a global carbon cap-and-trade program
B) a global financial crisis
C) a decrease in the price of oil
D) thermonuclear war
Answer: B
Diff: 2 Type: MC
Skill: Recall
given a negative aggregate demand shock is that ________.
A) with the credible policy there is no shift in the aggregate supply curve
Answer: A
Diff: 2 Type: MC
Skill: Recall
26) Which of the following components is NOT included in the equation for the short-run
aggregate supply curve?
A) Nominal interest rate
B) Inflation
C) Expected inflation
D) Output gap
Answer: A
Diff: 2 Type: MC
Skill: Recall
27) With a negative aggregate supply shock, monetary policy credibility can ________.
A) produce a better outcome
Answer: A
Diff: 2 Type: MC
Skill: Recall
21
28) If a negative aggregate supply shock occurs and monetary policy is not credible then
________.
A) inflation will higher and output lower than with credible policy
B) the equilibrium interest rate will fall
C) there will be a corresponding autonomous decrease in aggregate supply
Answer: A
Diff: 2 Type: MC
Skill: Recall
29) A negative aggregate supply shock will impact ________.

A) the equilibrium output
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
30) An example of a negative supply shock is ________.

A) carbon cap-and-trade program
B) a rapid increase in energy costs
C) a fall in the price of oil
D) the shale gas revolution
Answer: B
Diff: 2 Type: MC
Skill: Recall
given a negative aggregate supply shock is that ________.
A) the overall economic outlook is better
Answer: A
Diff: 2 Type: MC
Skill: Recall
22
32) The three big oil price shocks occurred in ________.
A) 1973, 1979, 2007
B) 1972, 1979, 2007
C) 1973, 1978, 2007
D) 1973, 1979, 2006
Answer: A
Diff: 2 Type: MC
Skill: Recall
33) After the first two oil price shocks ________.

A) the Canadian inflation rate increased sharply
B) the Bank of Canada reversed its monetary policy stance
C) there was no discernable impact on aggregate output
D) the Bank of Canada implemented a nominal credible anchor policy
Answer: A
Diff: 2 Type: MC
Skill: Recall
34) The oil shock in 2007 ________.

A) had little impact on the inflation rate in Canada
B) led to a sharp increase in the inflation rate
C) did not impact Canadian output
D) was beneficial to the Canadian economy because Canada is a net exporter of oil
Answer: A
Diff: 2 Type: MC
Skill: Recall
35) The reason Canada fared differently between the first two oil shocks and the third is
because ________.
A) a nominal anchor was in place during the third oil shock in 2007
B) by 2007 Canada became a net exporter of oil, so Canadians benefitted from higher oil prices
C) in 2007, the global financial crisis overshadowed any oil price shocks
Answer: A
Diff: 2 Type: MC
Skill: Recall
23
36) The global economic crisis that arose in October 2008 was the result of ________.
A) higher oil prices
B) the collapse of the subprime mortgage market
C) the European debt crisis
D) fiscal and monetary issues stemming from the US debt ceiling
Answer: A
Diff: 2 Type: MC
Skill: Recall
37) The oil crisis in the 1970s led to an unemployment rate of over ________ percent.
A) 13
B) 12
C) 10
D) 14
Answer: A
Diff: 2 Type: MC
Skill: Recall
38) The ________ is the credibility of the central bank, the more rapid will be the ________ in
inflation and the ________ will be the loss of output to achieve the inflation objective.
A) greater; decline; lower
B) greater; increase; lower
C) greater; decline; greater
D) greater; increase; greater
Answer: A
Diff: 2 Type: MC
Skill: Recall
39) Empirical evidence on the importance of credibility in dealing with inflation includes
experience from countries such as ________.
A) Bolivia
B) Argentina
C) Zimbabwe
D) Brazil
Answer: A
Diff: 2 Type: MC
Skill: Recall
24
40) The Bank of Canada has not always had a reputation for garnering credibility. These
include countervailing monetary policies in ________.
A) early 1970s
B) early 1960s
C) the course of the Coyne affair
D) during the global financial crisis
Answer: A
Diff: 2 Type: MC
Skill: Recall
41) in the 1970s when faced with inflation shocks, the Bank of Canada ________.
A) increased the growth rate of the monetary aggregates
B) decreased the growth rate of monetary aggregates
C) began to accept the Lucas critique
D) instituted contractionary monetary policy
Answer: A
Diff: 2 Type: MC
Skill: Recall
42) Between 1981 and 1981, Canada experienced ________.

A) a reduction in inflation
B) a gradual increase in inflation
C) a sharp increase in inflation
D) lower than average interest rates
Answer: A
Diff: 2 Type: MC
Skill: Recall
43) In the first half of 1985, Bolivia's inflation rate was approximately ________.
A) 200,000 percent
B) 20000 percent
C) 2000 percent
D) 200 percent
Answer: B
Diff: 2 Type: MC
Skill: Recall
25
44) In August 1985, the Bolivian government announced ________.
A) it would no longer pay government employees with money
B) the New Economic Policy
C) a credible nominal anchor
D) a change in the head of state
Answer: A
Diff: 2 Type: MC
Skill: Recall
45) Which of the following formed part of the Bolivian government plan to reduce inflation?
A) Daily balancing of the budget
B) Contractionary monetary policy
C) Creation of a new currency
D) Nationalization of 10 percent of private industrial activity
Answer: A
Diff: 2 Type: MC
Skill: Recall
46) The New Economic Policy implemented by the Bolivian government to reduce inflation,
resulted in a output loss of ________ percent of GDP.
A) 1 percent
B) 5 percent
C) 10 percent
D) nearly 18 percent
Answer: B
Diff: 2 Type: MC
Skill: Recall
47) Prior to 1980, Canada's inflation rate ________.

A) was growing at a slow and stable rate
B) was never considered to be difficult to control
C) reached double digits
D) was tied to the U.S. inflation rate
Answer: A
Diff: 2 Type: MC
Skill: Recall
26
48) To bring credibility to the Bank of Canada, Gerald Bouey, the governor created ________.
A) double digit inflation
B) two severe recessions in the 1980s
C) a reorganization with the Bank of Canada
D) a new measure of monetary aggregates
Answer: A
Diff: 2 Type: MC
Skill: Recall
49) The 1981-1982 recession yielded an unemployment rate of ________.

A) just less than 10 percent
B) 10 percent
C) just over 10 percent
D) 20 percent
Answer: A
Diff: 2 Type: MC
Skill: Recall
25.4 Approaches to Establishing Central Bank Credibility
1) Approaches to establishing central bank credibility include ________.

A) continued success at keeping inflation under control
B) central bank independence
C) appointment of a more conservative central banker
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 25.4 Identify ways in which central banks can establish and maintain credibility

A) continued success at keeping inflation under control
B) inflation targeting
C) exchange rate targeting
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
27
A) inflation targeting
B) exchange rate targeting
C) central bank independence
D) appointment of a more conservative central banker
E) all of the above
Answer: E
Diff: 2 Type: MC
Skill: Recall
4) The notion of hiring central bankers who are "conservative" and have a strong aversion to
inflation was introduced by ________.
A) Kenneth Galbraith
B) Ben Bernanke
C) Gerald Bouey
D) Kenneth Rogoff
Answer: A
Diff: 2 Type: MC
Skill: Recall
5) Provide several ways that the central bank could establish credibility.
Answer: Some ways in which the central bank could establish credibility include: continued
success of keeping inflation under control, inflation targeting, public announcements of
medium-term numerical targets for inflation, giving the central bank more independence from
the political process, appoint "conservative" central bankers who have a strong aversion to
inflation.
Diff: 2 Type: ES
Skill: Recall
6) Describe the two main benefits of a credible nominal anchor.

Answer: First, a credible nominal anchor acts like a behaviour rule and reduces the issues
associated with the time-inconsistency problem. Second, a credible commitment to a nominal
anchor will help anchor inflation expectations which leads to smaller fluctuations in inflation
which helps with price stability.
Diff: 2 Type: ES
Skill: Recall
28
7) Explain how the impacts of a positive aggregate demand shock can be mitigated by
monetary policy credibility.
Answer: Monetary policy credibility has the benefit of stabilizing inflation in the short run
when faced with a positive demand shock as the public's expectation of inflation will remain
unchanged.
Diff: 2 Type: ES
Skill: Recall
8) Explain the difference in how the Canadian economy responding during the three oil shocks
and the role monetary policy credibility played.
Answer: Three oil shocks occurred in 1973, 1979 and 2007. After the first two episodes,
monetary policy was weak because the Bank of Canada was unable to keep inflation under
control and inflation increased to over 10 percent. During the oil crisis in 2007, the Bank of
Canada had established monetary policy credibility and inflation never rose about 4 percent.
Economists attribute the lower inflation rate to the credibility of the Bank of Canada in keeping
inflation within the target range.
Diff: 2 Type: ES
Skill: Recall
9) Explain why the Bank of Canada had a credibility problem during the 1970s.
Answer: In the early 1970s, the Bank of Canada accommodated inflationary shocks by raising
the rate of growth of monetary aggregates, thereby forming expectations of rising inflation.
When in 1975 the Bank of Canada adopted a gradual anti-inflation policy, the public had no
reason to believe in such a policy. This reduced the credibility of the Bank of Canada in the
eyes of the public.
Diff: 2 Type: ES
Skill: Recall
10) Describe how the Bolivian government managed its hyperinflation by introducing
credibility.
Answer: In the first half of 1985, the Bolivian economy faced inflation of 20000 percent. In
August 1985, the Bolivian president announced his anti-inflation program, the New Economic
Plan. To rein in money growth and establish credibility, the new government reduced the
budget deficit by shutting down state owned enterprises, eliminated subsidies, freezing public
sector salaries and collecting a new wealth tax. The budget was balanced on a day-by day-basis.
The Finance minister would not authorize spending in excess of the amount of tax revenue that
had been collected the day before. The Bolivian inflation was stopped within one month and
output loss was less than 5 percent of GDP.
Diff: 2 Type: ES
Skill: Recall
29
11) How did Canada win the battle against inflation?
Answer: The Bank of Canada battled against double digit inflation and stayed the course over
two major recessions in the 1980s. By the end of 1983, inflation had fallen to less than 5
percent. In 1988, the Bank of Canada and federal government announced jointly a series of
inflation targets.
Diff: 2 Type: ES
Skill: Recall
12) Provide some alternate approaches to establishing credibility.

Answer: To achieve credibility, the central bank may announce inflation targeting or exchange
rate targeting that allows a country to peg its exchange rate to an anchor country that has a
strong nominal anchor. Another method is to appoint central bankers who have a strong version
to inflation.
Diff: 2 Type: ES
Skill: Recall
13) Describe how a nominal anchor can help a central bank achieve credibility.
Answer: An important way to constrain discretion is to commit to a nominal anchor that ties
down the price level or inflation to achieve price stability. If the commitment to a nominal
anchor has credibility, i.e., its believed by the public, it can act as a behaviour rule and will
anchor expectations reducing output fluctuations.
Diff: 2 Type: ES
Skill: Recall
30

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Economics of Money, Banking, and Financial Markets 6e (Mishkin)

Chapter 25 The Role of Expectations in Monetary Policy

25.1 Lucas Critique of Policy Evaluation

1) Today, most economists ________.

3) The argument that econometric policy evaluation is likely to be misleading if policymakers

6) The Lucas critique indicates that ________.

7) The Lucas critique is an attack on the usefulness of ________.

9) A rise in short-term interest rates that is believed to be only temporary ________.

2) The Lucas critique highlighted the need for ________.

3) Operating with discretion in a monetary policy sense implies ________.

6) The best way to keep inflation under control is to ________.

7) The opposite of a discretionary approach is a ________ approach.

8) Milton Friedman and his followers are known as ________.

10) An example of a rule used in non-discretionary monetary policy is ________.

12) The political business cycle can lead to ________.

14) One of the drawbacks of rules based monetary policy is ________.

15) One of the drawbacks of rules based monetary policy is ________.

16) One of the drawbacks of rules based monetary policy is ________.

18) One of the drawbacks of rules based monetary policy is ________.

30) Monetarists contend that ________.

32) Monetarists believe all of the following except that ________.

33) Arguments for adopting a policy rule include ________.

35) Arguments for discretionary policies include ________.

36) Arguments for discretionary policies include ________.

1) A credible nominal anchor ________.

13) An example of a nominal anchor is ________.

14) The benefits of a credible nominal anchor include ________.

15) The benefits of a credible nominal anchor include ________.

18) A positive aggregate demand shock will only impact ________.

19) An example of a positive aggregate demand shock is ________.

23) A negative aggregate demand shock will only impact ________.

29) A negative aggregate supply shock will impact ________.

30) An example of a negative supply shock is ________.

33) After the first two oil price shocks ________.

34) The oil shock in 2007 ________.

42) Between 1981 and 1981, Canada experienced ________.

47) Prior to 1980, Canada's inflation rate ________.

49) The 1981-1982 recession yielded an unemployment rate of ________.

25.4 Approaches to Establishing Central Bank Credibility

1) Approaches to establishing central bank credibility include ________.

2) Approaches to establishing central bank credibility include ________.

6) Describe the two main benefits of a credible nominal anchor.

12) Provide some alternate approaches to establishing credibility.

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