Chapter 37 Mankiw/Taylor, Economics

Name:

True/False
Indicate whether the sentence or statement is true or false.

Monetary policy affects the economy with a lag but fiscal policy has no lag.

Discretionary monetary policy suffers from time inconsistency because policy makers have an incentive to engage in a policy that differs from their policy announcements.

The political business cycle refers to a situation where corporate executives also hold political office.

Opponents of a monetary policy rule argue that a rule would make it more difficult for the central bank to respond to an unusual crisis.

Government budget deficits tend to redistribute wealth from the current generation to future generations.

Replacing the income tax with a consumption tax may increase saving, but it will tend to benefit the rich more than the poor.

A reduction in taxes on interest income will increase saving if the substitution effect from the increase in after-tax interest outweighs the income effect.

The European Central Bank pursues an inflation targeting policy so that monetary policy in the euro area is set in a fashion that is similar to the way the Bank of England sets monetary policy.

While monetary policy may have no effect on output and employment in the long run, a one size fits all monetary policy in the euro area that did not suit economic conditions in the UK could cause substantial short-run fluctuations in output and employment.

10.

The UK economy grew faster than the euro area economy in the first few years after the euro’s launch.

Multiple Choice
Identify the letter of the choice that best completes the statement or answers the question.

11.

Suppose that the consumers and firms in an economy are pessimistic about the future and reducing their expenditure. Which of the following is an activist stabilization policy that "leans against the wind?"

a.	Policy makers should increase taxes.
b.	none of these answers
c.	Policy makers should decrease the money supply.
d.	Policy makers should decrease government spending.
e.	Policy makers should decrease interest rates.

12.

Economists who argue that policy makers should not try to stabilize the economy make all of the following arguments except which one?

a.	Since stabilization policy affects the economy with a lag, well-intended policy could be destabilizing.
b.	Stabilization policy has no effect on the economy in the short run or the long run.
c.	Since forecasting shocks to the economy is difficult, well-intended policy could be destabilizing.
d.	The first rule of policy making should be "do no harm."

13.

Fluctuations in the economy caused by policy maker's manipulation of the economy for the purpose of affecting electoral outcomes is known as the

a.	time inconsistency of policy.
b.	income effect.
c.	discretionary effect.
d.	substitution effect.
e.	political business cycle.

14.

The discrepancy between policy announcements and policy actions is known as the

a.	time inconsistency of policy.
b.	income effect.
c.	substitution effect.
d.	political business cycle.
e.	discretionary effect.

15.

Economists who argue that monetary policy should be made by a rule make all of the following arguments except which one?

a.	A policy rule is more flexible than discretionary policy.
b.	A policy rule limits the abuse of power of policy makers.
c.	A policy rule limits the incompetence of policy makers.
d.	A policy rule eliminates the time inconsistency problem.

16.

Which of the following is an example of a discretionary policy action that further destabilizes the economy?

a.	Investors become excessively optimistic, and the central bank responds with a reduction in the money supply.
b.	Investors become pessimistic, and the central bank responds with a reduction in interest rates.
c.	Consumers become pessimistic, and fiscal policy makers respond with a reduction in taxes.
d.	Consumers become pessimistic, and fiscal policy makers respond with a reduction in government spending.

17.

A government budget deficit tends to

a.	none of these answers
b.	redistribute wealth from future generations to the current generation.
c.	redistribute wealth from the current generation to future generations.
d.	have no redistributive effects.

18.

Which of the following is not true with regard to government budget deficits?

a.	Budget deficits reduce capital investment, future productivity and, therefore, future incomes.
b.	Budget deficits place the burden of current spending on future taxpayers.
c.	Budget deficits should be scrutinized because they are the only way to transfer wealth across generations of taxpayers.
d.	Budget deficits reduce national saving.

19.

Economists who argue that the government need not balance its budget make all of the following arguments except which one?

a.	Budget deficits increase future growth because they transfer wealth from the present generation to future generations.
b.	As long as the budget deficit is used to finance investment spending rather than current government spending then a budget deficit is quite acceptable.
c.	Budget deficits will not become an increasing burden as long as they do not grow more quickly than a nation's nominal income.
d.	Cutting the budget deficit means the tax burden on future generations can be lower; but if the deficit reduction is achieved by reducing spending on public services such as education then it may mean that younger generations have lower productivity, and so lower incomes, than would otherwise have been the case.

20.

Which of the following changes to tax laws would encourage more saving but also increase the tax burden on low-income people?

a.	Remove the double taxation on capital income from stocks
b.	Replace the income tax with a consumption tax
c.	Reduce inheritance taxes
d.	Reduce taxes on the return to saving
e.	All of the changes described in these answers

21.

A reduction in taxes that increases the after-tax return to saving will increase the quantity of saving in the economy if the

a.	substitution effect from the increase in after-tax return to saving exceeds the income effect.
b.	policy is time inconsistent.
c.	income effect from the increase in after-tax return to saving equals the substitution effect.
d.	income effect from the increase in after-tax return to saving exceeds the substitution effect.

22.

Tax reform that encourages saving tends to

a.	shift the tax burden toward low-income people away from high-income people.
b.	reduce the rate of growth of output.
c.	reduce the deficit.
d.	shift the tax burden toward high-income people away from low-income people.

23.

If discretionary monetary policy is time inconsistent,

a.	the long-run Phillips curve shifts to the left.
b.	the short-run Phillips curve shifts downward.
c.	the short-run Phillips curve shifts upward.
d.	the long-run Phillips curve shifts to the right.

24.

Which one of the following is not one of the UK government’s five tests that must be passed before a strong case can be made for the UK joining the European Economic and Monetary Union (EMU)?

a.	Are business cycles and economic structures compatible so that the UK could live permanently with euro interest rates?
b.	Would joining the euro promote higher growth, stability and a lasting increase in jobs?
c.	If problems emerge, is there sufficient flexibility to deal with them?
d.	Would joining the euro encourage investment?
e.	Is the UK’s trade with other countries outside of the euro area declining?

25.

Which one of the following is not true?

a.	The UK Treasury concluded in 1997 that the City of London would do better if the UK were to adopt the euro than it would if the UK were to remain outside the eurozone.
b.	If EMU leads to greater financial market integration then, if there were an asymmetric macroeconomic shock that pushed one country into recession, its firms and consumers could borrow from other euro area residents through the financial system to tide them over until the economy recovers.
c.	About a third of UK trade takes place with other European countries.
d.	Outside of the EMU, if the UK’s productivity rises more slowly than it does in the Eurozone, then UK competitiveness can be maintained by depreciation of the pound’s foreign exchange value against the euro; but if the UK were in the eurozone, then wage rates would have to fall relative to wage rates in other eurozone countries.
e.	The UK has benefited from a great deal of foreign direct investment, but if the UK remains outside of the euro area then overseas firms, such as Nissan and Honda, may decide it is better to locate their production facilities in the Eurozone and so avoid the transaction costs and uncertainty that having to deal with the pound-euro exchange rate brings.