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222 ❖ Chapter 30 /Money Growth and Inflation Chapter 30 Money Growth and Inflation TRUE/FALSE The inflation rate is measured as the percentage change in a price index ANS: T DIF: REF: 30-0 NAT: Analytic LOC: Unemployment and inflation TOP: KEY: MSC: Definitional Inflation U.S prices rose at an average annual rate of about percent over the last 70 years ANS: T DIF: REF: 30-0 NAT: Analytic LOC: The role of money TOP: Inflation MSC: Analytical The United States has never had deflation ANS: F DIF: REF: NAT: Analytic LOC: The role of money MSC: Definitional 30-0 TOP: In the 1990s, U.S prices rose at about the same rate as in the 1970s ANS: F DIF: REF: 30-0 NAT: Analytic LOC: The role of money TOP: MSC: Definitional As the price level falls, the value of money falls ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money MSC: Interpretive TOP: The price level is determined by the supply of, and demand for, money ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: MSC: Definitional Deflation U.S inflation Value | Money Money market If the quantity of money supplied is greater than the quantity demanded, then prices should fall ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money market MSC: Analytical Dollar prices and relative prices are both nominal variables ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Nominal variables | Real variables MSC: Definitional The quantity equation is M x V = P x Y ANS: T DIF: REF: NAT: Analytic LOC: The role of money MSC: Definitional 30-1 TOP: Quantity equation 10 According to the Fisher effect, if inflation rises then the nominal interest rate rises ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Fisher effect MSC: Definitional 11 An increase in money demand would create a surplus of money at the original value of money ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money market MSC: Applicative 223 ❖ Chapter 30 /Money Growth and Inflation 12 Hyperinflations are associated with governments printing money to finance expenditures ANS: T DIF: REF: 30-1 NAT: Analytic LOC: Unemployment and inflation TOP: Hyperinflation MSC: Definitional 13 For a given level of money and real GDP, an increase in velocity would lead to an increase in the price level ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Velocity of money MSC: Analytical 14 The quantity theory of money can explain hyperinflations but not moderate inflation ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Hyperinflation MSC: Interpretive 15 If P represents the price of goods and services measured in money, then 1/P is the value of money measured in terms of goods and services ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money | Value MSC: Interpretive 16 When the value of money is on the vertical axis, an increase in the price level shifts money demand to the right ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money demand MSC: Applicative 17 The money supply curve shifts to the left when the Fed buys government bonds ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money supply MSC: Analytical 18 When the value of money is on the vertical axis, the money supply curve slopes upward because an increase in the value of money induces banks to create more money ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money supply MSC: Definitional 19 If the Fed increases the money supply, the equilibrium value of money decreases and the equilibrium price level increases ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Money market MSC: Analytical 20 A rising price level eliminates an excess supply of money ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money MSC: Analytical 21 A rising value of money eliminates an excess supply of money ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money MSC: Analytical TOP: Money market TOP: Money market 22 Nominal GDP measures output of final goods and services in physical terms ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Nominal variables MSC: Interpretive Chapter 30 /Money Growth and Inflation ❖ 224 23 The classical dichotomy is useful for analyzing the economy because in the long run nominal variables are heavily influenced by developments in the monetary system, and real variables are not ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Classical dichotomy MSC: Definitional 24 The irrelevance of monetary changes for real variables is called monetary neutrality Most economists accept monetary neutrality as a good description of the economy in the long run, but not the short run ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Monetary neutrality MSC: Interpretive 25 The quantity theory of money implies that if output and velocity are constant, then a 50 percent increase in the money supply would lead to less than a 50 percent increase in the price level ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity theory MSC: Applicative 26 The source of all four classic hyperinflations was high rates of money growth ANS: T DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Hyperinflation MSC: Definitional 27 In the long run, an increase in the growth rate of the money supply leads to an increase in the real interest rate, but no change in the nominal interest rate ANS: F DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity theory MSC: Definitional 28 Inflation induces people to spend more resources maintaining lower money holdings The costs of doing this are called shoeleather costs ANS: T DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Shoeleather costs of inflation MSC: Definitional 29 Shoeleather costs and menu costs are both costs of anticipated inflation ANS: T DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Shoeleather costs of inflation | Menu costs of inflation MSC: Definitional 30 For a given real interest rate, an increase in the inflation rate reduces the after-tax real interest rate ANS: T DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Inflation | Taxes | Real interest rate MSC: Analytical 31 Inflation necessarily distorts saving when either real interest income or nominal interest income is taxed ANS: F DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Inflation | Real interest rate MSC: Interpretive 32 Inflation distorts savings when real interest income, rather than nominal interest income, is taxed ANS: F DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Inflation | Real interest rate MSC: Interpretive 33 Suppose the nominal interest rate is 10 percent; the tax rate on interest income is 28 percent, and the inflation rate is percent Then the after-tax real interest rate is -3.2 percent ANS: F DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Real interest rate MSC: Interpretive 225 ❖ Chapter 30 /Money Growth and Inflation 34 Suppose the nominal interest rate is percent; the tax rate on interest income is 30 percent, and the after-tax real interest rate is 0.8 percent Then the inflation rate is 2.7 percent ANS: T DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Real interest rate MSC: Interpretive 35 If the Fed were to unexpectedly increase the money supply, creditors would gain at the expense of debtors ANS: F DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Applicative 36 If inflation is higher than expected, then borrowers make nominal interest payments that are less than they expected ANS: F DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Menu costs of inflation MSC: Applicative 37 Inflation is costly only if it is unanticipated ANS: F DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation MSC: Interpretive TOP: Inflation costs 38 Even though monetary policy is neutral in the short run, it may have profound real effects in the long run ANS: F DIF: REF: 30-3 NAT: Analytic LOC: The role of money TOP: Monetary neutrality MSC: Interpretive SHORT ANSWER Why did farmers in the late 1800s dislike deflation? ANS: Most had large nominal debts The decrease in the price level meant that they received less for what they produced and so made it harder to pay off the debts whose real value rose as prices fell DIF: REF: LOC: The role of money 30-1 NAT: TOP: Analytic Deflation MSC: Analytical Explain the adjustment process in the money market that creates a change in the price level when the money supply increases ANS: When the money supply increases, there is an excess supply of money at the original value of money After the money supply increases, people have more money than they want to hold in their purses, wallets and checking accounts They use this excess money to buy goods and services or lend it out to other people to buy goods and services The increase in expenditures causes prices to rise and the value of money to fall As the value of money falls, the quantity of money people want to hold increases so that the excess supply is eliminated At the end of this process the money market is in equilibrium at a higher price level and a lower value of money DIF: REF: LOC: The role of money MSC: Analytical 30-1 NAT: TOP: Analytic Money market Chapter 30 /Money Growth and Inflation ❖ 226 Suppose the Fed sells government bonds Use a graph of the money market to show what this does to the value of money ANS: When the Fed sells government bonds, the money supply decreases This shifts the money supply curve from MS1 to MS2 and makes the value of money increase Since money is worth more, it takes less to buy goods with it, which means the price level falls DIF: REF: LOC: The role of money MSC: Analytical 30-1 NAT: TOP: Analytic Money market Using separate graphs, demonstrate what happens to the money supply, money demand, the value of money, and the price level if: a the Fed increases the money supply b people decide to demand less money at each value of money ANS: a b The Fed increases the money supply When the Fed increases the money supply, the money supply curve shifts right from MS1 to MS2 This shift causes the value of money to fall, so the price level rises People decide to demand less money at each value of money Since people want to hold less at each value of money, it follows that the money demand curve will shift to the left from MD1 to MD2 The decrease in money demand results in a lower value of money and so a higher price level DIF: REF: LOC: The role of money MSC: Analytical 30-1 NAT: TOP: Analytic Money market 227 ❖ Chapter 30 /Money Growth and Inflation According to the classical dichotomy, what changes nominal variables? What changes real variables? ANS: The classical dichotomy argues that nominal variables are determined primarily by developments in the monetary system such as changes in money demand and supply Real variables are largely independent of the monetary system and are determined by productivity and real changes in the factor and loanable funds markets DIF: REF: LOC: The role of money MSC: Definitional 30-1 NAT: TOP: Analytic Classical dichotomy Suppose that monetary neutrality holds Of the following variables, which ones not change when the money supply increases? a real interest rates b inflation c the price level d real output e real wages f nominal wages ANS: a d e real interest rates real output real wages DIF: REF: LOC: The role of money MSC: Interpretive 30-1 NAT: TOP: Analytic Monetary neutrality Wages and prices are many times higher today than they were 30 years ago, yet people not work a lot more hours or buy fewer goods How can this be? ANS: Inflation has raised the general price level An increase in the general price level has no effect on real variables in the long run Wages are higher, but so are prices Prices are higher, but so are wages and incomes In the long run, people change their behavior in response to changes in real variables, not nominal ones DIF: REF: LOC: The role of money MSC: Interpretive 30-1 NAT: TOP: Analytic Nominal variables | Real variables Identify each of the following as nominal or real variables a the physical output of goods and services b the overall price level c the dollar price of apples d the price of apples relative to the price of oranges e the unemployment rate f the amount that shows up on your paycheck after taxes g the amount of goods you can purchase with the wage you get each hour h the taxes that you pay the government ANS: a b c d e f g h real variable nominal variable nominal variable real variable real variable nominal variable real variable nominal variable DIF: REF: LOC: The role of money MSC: Interpretive 30-1 NAT: TOP: Analytic Nominal variables | Real variables Chapter 30 /Money Growth and Inflation ❖ 228 Define each of the symbols and explain the meaning of M V = P Y ANS: M is the quantity of money, V is the velocity of money, P is the price level, and Y is the quantity of output P Y is nominal GDP The amount people spend should equal the amount of money in the economy times the average number of times each unit of currency is spent DIF: REF: LOC: The role of money 10 30-1 NAT: TOP: Analytic Velocity MSC: Definitional What assumptions are necessary to argue that the quantity equation implies that increases in the money supply lead to proportional changes in the price level? ANS: We must suppose that V is relatively constant and that changes in the money supply have no effect on real output DIF: REF: LOC: The role of money MSC: Definitional 30-1 NAT: TOP: Analytic Quantity theory 11 What is the inflation tax, and how might it explain the creation of inflation by a central bank? ANS: The inflation tax refers to the fact that inflation is a tax on money When prices rise, the value of money currently held is reduced Hence, when a government raises revenue by printing money, it obtains resources from households by taxing their money holdings through inflation rather than by sending them a tax bill In countries where governments are unable or unwilling to raise revenues by raising taxes explicitly, the inflation tax may be an alternative source of revenue DIF: REF: LOC: The role of money 12 30-1 NAT: TOP: Analytic Inflation tax MSC: Interpretive Economists agree that increases in the money-supply growth rate increase inflation and that inflation is undesirable So why have there been hyperinflations and how have they been ended? ANS: Typically, the government in countries that had hyperinflation started with high spending, inadequate tax revenue, and limited ability to borrow Therefore, they turned to the printing presses to pay their bills Massive and continued increases in the quantity of money led to hyperinflation, which ended when the governments instituted fiscal reforms eliminating the need for the inflation tax and subsequently slowed money supply growth DIF: REF: LOC: The role of money MSC: Interpretive 13 30-1 NAT: TOP: Analytic Hyperinflation Suppose that velocity and output are constant and that the quantity theory and the Fisher effect both hold What happens to inflation, real interest rates, and nominal interest rates when the money supply growth rate increases from percent to 10 percent? ANS: Inflation and nominal interest rates each increase by percent points There is no change in the real interest rate or any other real variable DIF: REF: LOC: The role of money 30-1 NAT: TOP: Analytic Inflation MSC: Analytical 229 ❖ Chapter 30 /Money Growth and Inflation 14 In recent years Venezuela and Russia have had much higher nominal interest rates than the United States while Japan has had lower nominal interest rates What would you predict is true about money growth in these other countries? Why? ANS: The Fisher effect says that increases in the inflation rate lead to one-to-one increases in nominal interest rates The quantity theory says that in the long run, inflation increases one-to-one with money supply growth It follows that differences in nominal interest rates may be due to differences in money supply growth rates It is reasonable to guess that much higher nominal interest rates in Venezuela and Russia indicate higher money supply growth while lower interest rates in Japan indicate lower money supply growth DIF: REF: LOC: The role of money 15 30-1 NAT: TOP: Analytic Fisher effect MSC: Applicative The U.S Treasury Department issues inflation-indexed bonds What are inflation-indexed bonds and why are they important? ANS: Inflation-indexed bonds are bonds whose interest and principal payments are adjusted upward for inflation, guaranteeing their real purchasing power in the future They are important because they provide a safe, inflationproof asset for savers and they may allow the Treasury to borrow more easily at a lower current cost DIF: REF: LOC: The role of money 30-1 NAT: TOP: Analytic Index bonds MSC: Definitional 16 List and define any two of the costs of high inflation ANS: The costs include: Shoeleather costs: the resources wasted when inflation induces people to reduce their money holdings Menu costs: the cost of more frequent price changes at higher inflation rates Relative Price Variability: because prices change infrequently, higher inflation causes relative prices to vary more Decisions based on relative prices are then distorted so that resources may not be allocated efficiently Inflation Induced Tax Distortions: the income tax is not completely indexed for inflation; an increase in nominal income created by inflation results in higher real tax rates that discourage savings Confusion and Inconvenience: inflation decreases the reliability of the unit of account making it more complicated to differentiate successful and unsuccessful firms thereby impeding the efficient allocation of funds to alternative investments Unexpected Inflation: inflation decreases the real value of debt thereby transferring wealth from creditors to debtors DIF: REF: LOC: The role of money MSC: Definitional 30-2 NAT: TOP: Analytic Inflation costs 17 Inflation distorts relative prices What does this mean and why does it impose a cost on society? ANS: Relative prices are the value of one good in terms of other goods Relative prices ordinarily provide signals concerning the relative scarcity of goods so the goods may be allocated efficiently Some prices change infrequently, so that when inflation rises, there is greater variation in relative prices However, changes in relative prices created by inflation not signal changes in the scarcity of goods and so lead to an inefficient allocation of goods and resources DIF: REF: LOC: The role of money MSC: Interpretive 30-2 NAT: TOP: Analytic Relative price variability Chapter 30 /Money Growth and Inflation ❖ 230 18 Explain how inflation affects savings ANS: Inflation discourages savings Income tax is collected on nominal rather than real interest rates So an increase in inflation will increase nominal interest rates and taxes The increase in taxes in turn lowers the real return on savings and so discourages savings DIF: REF: LOC: The role of money MSC: Applicative 19 30-2 NAT: TOP: Analytic Saving | Inflation The U.S Treasury Department began issuing inflation-indexed bonds in early 1997 Since these assets are virtually risk free, both in terms of default risk and inflation risk, will they quickly replace all other kinds of assets that still entail risk of one kind or another, such as ordinary government bonds or corporate bonds? Explain ANS: When individuals are choosing between assets of different kinds, they consider both expected return and risk Because the new inflation-indexed bonds have very low risk, they will also have very low real interest rates So they will not replace other, more risky assets that promise to pay a much higher real interest rate They do, however, offer a way of escaping some inflation risk, and have become a popular addition to portfolios DIF: REF: LOC: The role of money 30-2 NAT: TOP: Analytic Index bonds MSC: Analytical Sec00 - Money Growth and Inflation MULTIPLE CHOICE Over the past 70 years, prices in the U.S have risen on average about a percent per year b percent per year c percent per year d percent per year ANS: B NAT: Analytic MSC: Definitional Inflation rate DIF: REF: 30-0 LOC: Unemployment and inflation TOP: Inflation rate Over the last 70 years, the average annual U.S inflation rate was about a percent, implying that prices have increased 10-fold b percent, implying that prices have increased 10-fold c percent, implying that prices have increased 16-fold d percent, implying that prices increased about 16-fold ANS: D NAT: Analytic MSC: Definitional TOP: Over the past 70 years, the overall price level in the U.S has experienced a(n) a 4-fold increase b 8-fold increase c 12-fold increase d 16-fold increase ANS: D NAT: Analytic MSC: Definitional DIF: REF: 30-0 LOC: Unemployment and inflation DIF: REF: 30-0 LOC: Unemployment and inflation Inflation can be measured by the a change in the consumer price index b percentage change in the consumer price index c percentage change in the price of a specific commodity d change in the price of a specific commodity TOP: Inflation rate 231 ❖ Chapter 30 /Money Growth and Inflation ANS: B NAT: Analytic MSC: Definitional Inflation DIF: REF: 30-0 LOC: Unemployment and inflation TOP: Inflation rate DIF: REF: 30-0 LOC: Unemployment and inflation TOP: Inflation rate DIF: REF: 30-0 LOC: Unemployment and inflation TOP: Inflation rate TOP: Deflation When prices are falling, economists say that there is a disinflation b deflation c a contraction d an inverted inflation ANS: B NAT: Analytic MSC: Definitional 10 TOP: If the price level increased from 120 to 150, then what was the inflation rate? a 30 percent b 25 percent c 20 percent d None of the above is correct ANS: B NAT: Analytic MSC: Applicative DIF: REF: 30-0 LOC: Unemployment and inflation If the price level increased from 120 to 126, then what was the inflation rate? a percent b percent c percent d None of the above is correct ANS: B NAT: Analytic MSC: Applicative Inflation In which of the following cases was the inflation rate 10 percent over the last year? a One year ago the price index had a value of 110 and now it has a value of 120 b One year ago the price index had a value of 120 and now it has a value of 132 c One year ago the price index had a value of 126 and now it has a value of 140 d One year ago the price index had a value of 145 and now it has a value of 163 ANS: B NAT: Analytic MSC: Applicative TOP: Which of the following is not correct? a The inflation rate is measured as the percentage change in a price index b For the last 40 or so years, U.S inflation hasn’t shown much variation from its average rate of about percent c During the 19th century there were long periods of falling prices d Some economists argue that the costs of moderate inflation are not nearly as large as the general public believes ANS: B NAT: Analytic MSC: Interpretive DIF: REF: 30-0 LOC: Unemployment and inflation DIF: REF: 30-0 LOC: Unemployment and inflation Deflation a increases incomes and enhances the ability of debtors to pay off their debts b increases incomes and reduces the ability of debtors to pay off their debts c decreases incomes and enhances the ability of debtors to pay off their debts d decreases incomes and reduces the ability of debtors to pay off their debts ANS: D NAT: Analytic MSC: Interpretive DIF: REF: 30-0 LOC: Unemployment and inflation TOP: Deflation 261 ❖ Chapter 30 /Money Growth and Inflation 157 The nominal interest rate is percent and the real interest rate is percent What is the inflation rate? a percent b percent c percent d 12 percent ANS: B DIF: REF: NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate 30-1 MSC: Applicative 158 The nominal interest rate is percent and the real interest rate is percent What is the inflation rate? a 10 percent b percent c percent d 2.5 percent ANS: C DIF: REF: NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate 30-1 MSC: Applicative 159 If the nominal interest rate is percent and there is a deflation rate of percent, what is the real interest rate? a percent b percent c percent d 3/5 percent ANS: A DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate | Deflation MSC: Applicative 160 If the real interest rate is percent and the price level is falling at a rate of percent, what is the nominal interest rate? a percent b percent c percent d 10 percent ANS: A DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate | Deflation MSC: Applicative 161 The real interest rate is percent and the nominal interest rate is 10.5 percent Is there inflation or deflation? What is the inflation or deflation rate? a deflation; 2.5 percent b deflation; 20.5 percent c inflation; 2.5 percent d inflation; 20.5 percent ANS: C DIF: REF: NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate 30-1 MSC: Applicative 162 If the nominal interest rate is percent and the inflation rate is percent, then what is the real interest rate? a 10 percent b percent c percent d 2.5 percent ANS: C DIF: REF: 30-1 NAT: Analytic LOC: Unemployment and inflation TOP: Real and nominal interest rates MSC: Applicative Chapter 30 /Money Growth and Inflation ❖ 262 163 Whitney puts money in a savings account at her bank earning 3.5 percent One year later she takes her money out and notes that while her money was earning interest, prices rose 1.5 percent Whitney earned a nominal interest rate of a 3.5 percent and a real interest rate of percent b 3.5 percent and a real interest rate of percent c percent and a real interest rate of 3.5 percent d percent and a real interest rate of percent ANS: B DIF: REF: NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate 30-1 MSC: Applicative 164 Shawn puts money into an account One year later he sees that he has percent more dollars and that his money will buy percent more goods a The nominal interest rate was 11 percent and the inflation rate was percent b The nominal interest rate was percent and the inflation rate was percent c The nominal interest rate was percent and the inflation rate was -1 percent d None of the above is correct ANS: C DIF: REF: NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate 30-1 MSC: Applicative 165 Katarina puts money into an account One year later she sees that she has percent more dollars and that her money will buy percent more goods a The nominal interest rate was percent and the inflation rate was percent b The nominal interest rate was percent and the inflation rate was percent c The nominal interest rate was percent and the inflation rate was percent d None of the above is correct ANS: B DIF: REF: NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate 30-1 MSC: Applicative 166 Banks advertise a the real interest rate, which is how fast the dollar value of savings grows b the real interest rate, which is how fast the purchasing power of savings grows c the nominal interest rate, which is how fast the dollar value of savings grows d the nominal interest rate, which is how fast the purchasing power of savings grows ANS: C DIF: REF: 30-1 NAT: Analytic LOC: Unemployment and inflation TOP: Real and nominal interest rates MSC: Definitional 167 If a country experienced deflation, then a the nominal interest rate would be greater than the real interest rate b the real interest rate would be greater than the nominal interest rate c the real interest rate would equal the nominal interest rate d None of the above is necessarily correct ANS: B DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Real interest rate | Inflation 168 In the U.S., from the early 1980s through the early 1990s, a both inflation and nominal interest rates rose b both inflation and nominal interest rates fell c the inflation rate fell and the nominal interest rate rose d the inflation rate rose and the nominal interest rate fell ANS: B DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Nominal interest rate | Inflation MSC: Definitional MSC: Applicative 263 ❖ Chapter 30 /Money Growth and Inflation 169 The Fisher effect says that a the nominal interest rate adjusts one for one with the inflation rate b the growth rate of the money supply is negatively related to the velocity of money c real variables are heavily influenced by the monetary system d All of the above are correct ANS: A NAT: Analytic MSC: Definitional DIF: REF: LOC: The role of money 30-1 TOP: Fisher effect 170 Under the assumptions of the Fisher effect and monetary neutrality, if the money supply growth rate rises, then a both the nominal and the real interest rate rise b neither the nominal nor the real interest rate rise c the nominal interest rate rises, but the real interest rate does not d the real interest rate rises, but the nominal interest rate does not ANS: C NAT: Analytic MSC: Definitional DIF: REF: LOC: The role of money 30-1 TOP: Fisher effect 171 Under the assumptions of the Fisher effect and monetary neutrality, if the money supply growth rate falls, then a both the nominal and the real interest rate fall b neither the nominal nor the real interest rate fall c the nominal interest rate falls, but the real interest rate does not d the real interest rate falls, but the nominal interest rate does not ANS: C NAT: Analytic MSC: Definitional DIF: REF: LOC: The role of money 30-1 TOP: Fisher effect 172 When money is neutral, which of the following increases when the money supply growth rate increases? a real output growth b real interest rates c nominal interest rates d the money supply divided by the price level ANS: C NAT: Analytic MSC: Interpretive DIF: REF: LOC: The role of money 30-1 TOP: Monetary neutrality 173 Which of the following can a country increase in the long run by increasing its money growth rate? a the nominal wage divided by the price level b real output c real interest rates d None of the above is correct ANS: D NAT: Analytic MSC: Interpretive DIF: REF: LOC: The role of money 30-1 TOP: Monetary neutrality 174 Suppose that monetary neutrality and the Fisher effect both hold and the money supply growth rate has been the same for a long time Other things the same a higher money supply growth would be associated with a both higher inflation and higher nominal interest rates b a higher inflation rate, but not higher nominal interest rates c a higher nominal interest rate, but not higher inflation d neither a higher inflation rate nor a higher nominal interest rate ANS: A DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity equation | Fisher effect MSC: Applicative Chapter 30 /Money Growth and Inflation ❖ 264 175 Suppose that monetary neutrality and the Fisher effect both hold An increase in the money supply growth rate increases a the inflation rate and nominal interest rates b the inflation rate, but not nominal interest rates c nominal interest rates, but not the inflation rate d neither the inflation rate nor nominal interest rates ANS: A DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity equation | Fisher effect MSC: Applicative 176 Suppose that monetary neutrality and the Fisher effect both hold An increase in the money supply growth rate increases a the inflation rate and real interest rates b the inflation rate, but not real interest rates c real interest rates, but not the inflation rate d neither the inflation rate nor real interest rates ANS: B DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity equation | Fisher effect MSC: Applicative 177 Suppose that monetary neutrality and the Fisher effect both hold An increase in the money supply growth rate increases a the inflation rate and growth of real GDP b the inflation rate but not the growth rate of real GDP c the growth rate of real GDP, but not the inflation rate d neither the inflation rate nor the growth rate of real GDP ANS: B DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity equation | Fisher effect MSC: Applicative 178 Suppose that monetary neutrality and the Fisher effect both hold An increase in the money supply growth rate increases a the inflation rate and the nominal interest rate by the same number of percentage points b nominal interest rates but by less than the percentage point increase in the inflation rate c the inflation rate but not the nominal interest d neither the inflation rate nor the nominal interest rate ANS: A DIF: REF: 30-1 NAT: Analytic LOC: The role of money TOP: Quantity equation | Fisher effect MSC: Applicative 179 According to monetary neutrality and the Fisher effect, an increase in the money supply growth rate eventually increases a inflation, nominal interest rates, and real interest rates b inflation and nominal interest rates, but does not change real interest rates c inflation and real interest rates, but does not change nominal interest rates d neither inflation, nominal interest rates, or real interest rates ANS: B NAT: Analytic MSC: Analytical DIF: REF: LOC: The role of money 30-1 TOP: Quantity equation 180 The Fisher effect a says the government can generate revenue by printing money b says there is a one for one adjustment of the nominal interest rate to the inflation rate c explains how higher money supply growth leads to higher inflation d explains how prices adjust to obtain equilibrium in the money market ANS: B DIF: REF: 30-1 NAT: Analytic LOC: Unemployment and inflation TOP: Fisher effect | Real interest rate | Nominal interest rate MSC: Definitional 265 ❖ Chapter 30 /Money Growth and Inflation Sec02 - Money Growth and Inflation - The Costs of Inflation MULTIPLE CHOICE In the 1970s, the U.S inflation rate reached about a percent per year b 10 percent per year c 14 percent per year d 20 percent per year ANS: B NAT: Analytic MSC: Definitional TOP: Inflation DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Inflation fallacy DIF: REF: LOC: The role of money TOP: Inflation tax TOP: Inflation tax TOP: Shoeleather costs of inflation 30-2 People can reduce the inflation tax by a reducing savings b increasing deductions on their income tax c reducing cash holdings d None of the above is correct ANS: C NAT: Analytic MSC: Interpretive DIF: REF: 30-2 LOC: Unemployment and inflation The inflation tax a transfers wealth from the government to households b is the increase in income taxes due to lack of indexation c is a tax on everyone who holds money d All of the above are correct ANS: C NAT: Analytic MSC: Interpretive Inflation rate Which of the following helps to explain why the inflation fallacy is a fallacy? a Increases in the price level can be created by increases in money demand b Nominal incomes tend to rise at the same time that the price level is rising c As the price level rises, the value of a dollar falls d Inflation only changes nominal variables ANS: B NAT: Analytic MSC: Definitional TOP: Which of the following statements about inflation is correct? a Evidence from studies indicates that, in U.S newspapers, inflation is mentioned less frequently than other economic terms, such as unemployment and productivity b People believe the inflation fallacy because they tend to believe too strongly in the principle of monetary neutrality c Nominal incomes are determined by nominal factors; they are not affected by real factors d Inflation does not in itself reduce people’s real purchasing power ANS: D NAT: Analytic MSC: Definitional DIF: REF: 30-2 LOC: Unemployment and inflation DIF: REF: LOC: The role of money 30-2 Shoeleather costs arise when higher inflation rates induce people to a spend more time looking for bargains b spend less time looking for bargains c hold more money d hold less money ANS: D NAT: Analytic MSC: Definitional DIF: REF: 30-1 LOC: Unemployment and inflation Chapter 30 /Money Growth and Inflation ❖ 266 The shoeleather cost of inflation refers to a the redistributional effects of unexpected inflation b the time spent searching for low prices when inflation rises c the waste of resources used to maintain lower money holdings d the increased cost to the government of printing more money ANS: C NAT: Analytic MSC: Definitional TOP: Shoeleather costs of inflation DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Shoeleather costs of inflation DIF: REF: LOC: The role of money TOP: Shoeleather costs of inflation TOP: Menu costs of inflation TOP: Menu costs of inflation 30-2 When inflation rises, firms make a more frequent price changes This raises their menu costs b more frequent price changes This reduces their menu costs c less frequent price changes This raises their menu costs d less frequent price changes This reduces their menu costs ANS: A NAT: Analytic MSC: Definitional 12 DIF: REF: 30-2 LOC: Unemployment and inflation When inflation rises, people tend to go to the bank a more often, giving rise to menu costs b more often, giving rise to shoeleather costs c less often, giving rise to redistribution costs d less often, thereby lessening the severity of the inflation tax ANS: B NAT: Analytic MSC: Interpretive 11 Shoeleather costs of inflation People go to the bank more frequently to reduce currency holdings when inflation is high The sacrifice of time and convenience that is involved in doing that is referred to as a inflation-induced tax distortion b relative-price-variability cost c shoeleather cost d menu cost ANS: C NAT: Analytic MSC: Interpretive 10 TOP: Shoeleather cost refers to a the cost of more frequent price changes induced by higher inflation b the distortion in resource allocation created by distortions in relative prices due to inflation c resources used to maintain lower money holdings when inflation is high d the tendency to expend more effort searching for the lowest price when inflation is high ANS: C NAT: Analytic MSC: Definitional DIF: REF: 30-2 LOC: Unemployment and inflation DIF: REF: 30-2 LOC: Unemployment and inflation The costs of changing price tags and price listings are known as a inflation-induced tax distortions b relative-price variability costs c shoeleather costs d menu costs ANS: D NAT: Analytic MSC: Definitional DIF: REF: LOC: The role of money 30-2 267 ❖ Chapter 30 /Money Growth and Inflation 13 Menu costs refers to a resources used by people to maintain lower money holdings when inflation is high b resources used to price shop during times of high inflation c the distortion in incentives created by inflation when taxes not adjust for inflation d the cost of more frequent price changes induced by higher inflation ANS: D NAT: Analytic MSC: Definitional 14 DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Inflation | Relative prices DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Inflation | Relative prices DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Inflation | Relative prices Higher inflation makes relative prices a more variable, making it more likely that resources will be allocated to their best use b more variable, making it less likely that resources will be allocated to their best use c less variable, making it more likely that resources will be allocated to their best use d less variable, making it less likely that resources will be allocated to their best use ANS: B NAT: Analytic MSC: Definitional 18 Menu costs of inflation Relative-price variability is “automatic” when a firms change prices only once in a while b firms change prices often c people increase the frequency of their trips to the bank d people decrease the frequency of their trips to the bank ANS: A NAT: Analytic MSC: Interpretive 17 TOP: Relative-price variability a rises with inflation, leading to an improved allocation of resources b rises with inflation, leading to a misallocation of resources c falls with inflation, leading to an improved allocation of resources d falls with inflation, leading to a misallocation of resources ANS: B NAT: Analytic MSC: Interpretive 16 30-2 If there is inflation, then a firm that has kept its price fixed for some time will have a a high relative price Relative-price variability rises as the inflation rate rises b high relative price Relative-price variability falls as the inflation rate rises c low relative price Relative-price variability rises as the inflation rate rises d low relative price Relative-price variability falls as the inflation rate rises ANS: C NAT: Analytic MSC: Interpretive 15 DIF: REF: LOC: The role of money DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Relative-price variability When inflation causes relative-price variability, a consumer decisions are distorted and the ability of markets to efficiently allocate factors of production is impaired b consumer decisions are distorted, but markets are still able to efficiently allocate factors of production c consumer decisions are not distorted, but the ability of markets to efficiently allocate factors of production is impaired d consumer decisions are not distorted and markets are still able to efficiently allocate factors of production ANS: A NAT: Analytic MSC: Interpretive DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Inflation | Relative prices Chapter 30 /Money Growth and Inflation ❖ 268 19 If the inflation rate falls, people are likely to a change prices more frequently and go to the bank more frequently b change prices more frequently and go to the bank less frequently c change prices less frequently and go to the bank less frequently d change prices less frequently and go the bank more frequently ANS: C DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Shoeleather costs of inflation | Menu costs of inflation 20 When inflation rises, people a make less frequent trips to the bank and firms make less frequent price changes b make less frequent trips to the bank while firms make more frequent price changes c make more frequent trips to the bank while firms make less frequent price changes d make more frequent trips to the bank and firms make more frequent price changes ANS: D DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Menu costs of inflation | Shoeleather costs of inflation 21 DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Shoeleather costs of inflation U.S tax laws allow taxpayers, in computing the amount of tax they owe, to use the real value, as opposed to the nominal value, of a both interest income and capital gains b interest income but not capital gains c capital gains but not interest income d neither interest income nor capital gains ANS: D NAT: Analytic MSC: Definitional 23 MSC: Definitional When inflation rises, people will desire to hold a less money and will go to the bank less frequently b less money and will go to the bank more frequently c more money and will go to the bank less frequently d more money and will go to the bank more frequently ANS: B NAT: Analytic MSC: Interpretive 22 MSC: Interpretive DIF: REF: 30-2 LOC: Unemployment and inflation TOP: Taxes | Inflation In the U.S., taxes on capital gains are computed using a nominal gains This is one way by which higher inflation discourages saving b nominal gains This is one way by which higher inflation encourages saving c real gains This is one way by which higher inflation discourages saving d real gains This is one way by which higher inflation encourages saving ANS: A DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Taxes | Inflation | Capital gains MSC: Definitional 24 In the U.S., people are required to pay taxes on a nominal interest earnings, irrespective of their real interest earnings b real interest earnings, irrespective of their nominal interest earnings c real capital gains, irrespective of their nominal capital gains d All of the above are correct ANS: A NAT: Analytic MSC: Definitional DIF: REF: LOC: The role of money 30-2 TOP: Taxes | Inflation 269 ❖ Chapter 30 /Money Growth and Inflation 25 You bought some shares of stock and, over the next year, the price per share increased by percent, as did the price level Before taxes, you experienced a both a nominal gain and a real gain, and you paid taxes on the nominal gain b both a nominal gain and a real gain, and you paid taxes only on the real gain c a nominal gain, but no real gain, and you paid taxes on the nominal gain d a nominal gain, but no real gain, and you paid no taxes on the transaction ANS: C NAT: Analytic MSC: Analytical 26 30-2 TOP: Taxes | Inflation You bought some shares of stock and, over the next year, the price per share increased by percent and the price level increased by percent Before taxes, you experienced a both a nominal gain and a real gain, and you paid taxes on the nominal gain b both a nominal gain and a real gain, and you paid taxes only on the real gain c a nominal gain and a real loss, and you paid taxes on the nominal gain d a nominal gain and a real loss, and you paid no taxes on the transaction ANS: C NAT: Analytic MSC: Analytical 27 DIF: REF: LOC: The role of money DIF: REF: LOC: The role of money 30-2 TOP: Taxes | Inflation When deciding how much to save, people care most about a after-tax nominal interest rates b after-tax real interest rates c before-tax real interest rates d before-tax nominal interest rates ANS: B DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Definitional 28 For a given real interest rate, an increase in inflation makes the after-tax real interest rate a decrease, which encourages savings b decrease, which discourages savings c increase, which encourages savings d increase, which discourages savings ANS: B DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Analytical 29 Given a nominal interest rate of percent, in which of the following cases would you earn the highest after-tax real interest rate? a Inflation is percent; the tax rate is 20 percent b Inflation is percent; the tax rate is 30 percent c Inflation is percent; the tax rate is 40 percent d The after-tax real interest rate is the same for all of the above ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 30 Given a nominal interest rate of percent, in which of the following cases would you earn the highest after-tax real rate of interest? a Inflation is 2.5 percent; the tax rate is 25 percent b Inflation is percent; the tax rate is 20 percent c Inflation is percent; the tax rate is 30 percent d The after-tax real interest rate is the same for all of the above ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative Chapter 30 /Money Growth and Inflation ❖ 270 31 Given a nominal interest rate of percent, in which of the following cases would you earn the lowest after-tax real rate of interest? a Inflation is percent; the tax rate is percent b Inflation is percent; the tax rate is 20 percent c Inflation is percent; the tax rate is 30 percent d The after-tax real interest rate is the same for all of the above ANS: A DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 32 Given a nominal interest rate of percent, in which of the following cases would you earn the highest after-tax real rate of interest? a Inflation is percent; the tax rate is 20 percent b Inflation is percent; the tax rate is 40 percent c Inflation is percent; the tax rate is 60 percent d The after-tax real interest rate is the same for all of the above ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 33 You put money into an account that earns a percent nominal interest rate The inflation rate is percent, and your marginal tax rate is 20 percent What is your after-tax real rate of interest? a 3.4 percent b 1.6 percent c 1.0 percent d None of the above is correct ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 34 You put money into an account and earn a real interest rate of percent Inflation is percent, and your marginal tax rate is 20 percent What is your after-tax real rate of interest? a 1.2 percent b 2.8 percent c 4.8 percent d None of the above is correct ANS: B DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 35 You put money into an account and earn a real interest rate of percent Inflation is percent, and your marginal tax rate is 20 percent What is your after-tax real rate of interest? a 4.8 percent b 3.2 percent c 2.8 percent d None of the above is correct ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 36 You put money into an account and earn an after-tax real interest rate of 2.5 percent If the nominal interest rate on the account is percent and the inflation rate is percent, then what is the tax rate? a 28.00 percent b 36.25 percent c 43.75 percent d 67.50 percent ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 271 ❖ Chapter 30 /Money Growth and Inflation 37 Suppose that in some tax year you earned a nominal interest rate of percent During the time you held these funds inflation was percent You compute that you made a real after-tax interest rate of percent What was your tax rate? a 50 percent b 33.3 percent c 25 percent d None of the above are correct ANS: C DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Taxes | Inflation | Real interest rate MSC: Applicative 38 Suppose one year ago the price index was 120 and Mark purchased $20,000 worth of bonds One year later the price index is 126 Mark redeems his bonds for $22,250 and is in a 40 percent tax bracket What is Mark’s real after-tax rate of interest to the nearest tenth of a percent? a 4.3 percent b 3.1 percent c 1.8 percent d 1.2 percent ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Capital gains MSC: Applicative 39 The country of Lessidinia has a tax system identical to that of the United States Suppose someone in Lessidinia bought a parcel of land for 20,000 foci (the local currency) in 1960 when the price index equaled 100 In 2002, the person sold the land for 100,000 foci, and the price index equaled 600 The tax rate on nominal gains was 20 percent Compute the taxes on the nominal gain and the change in the real value of the land in terms of 2002 prices to find the after-tax real rate of capital gain a -60 percent b -30 percent c 30 percent d 60 percent ANS: B DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Capital gains MSC: Analytical 40 The country of Veridian has a tax system identical to that of the United States Suppose someone in Veridian bought a parcel of land for 10,000 deera (the local currency) in 1964 when the price index equaled 100 In 2005, the person sold the land for 100,000 deera, and the price index equaled 500 The tax rate on nominal capital gains was 20 percent Compute the taxes the person paid on the nominal gain and the change in the real value of the land in terms of 2005 prices to find the after-tax real rate of capital gain a -20 percent b 20 percent c 42 percent d 64 percent ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Capital gains MSC: Analytical 41 Kristi purchased one share of Genuine Co stock for $200; one year later she sold that share for $400 The inflation rate over the year was 50 percent The tax rate on nominal capital gains is 50 percent What was the tax on Kristi’s capital gain? a $50 b $75 c $100 d $200 ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Capital gains MSC: Applicative Chapter 30 /Money Growth and Inflation ❖ 272 42 Serena purchased 10 shares of GLC, Inc.stock for $200 per share; one year later she sold the 10 shares for $220 a share Over the year, the price level increased from 135.0 to 143.1 The tax rate on capital gains is 50 percent If the capital gains tax is on nominal gains, how much tax does Serena pay on her gain? a $90 b $95 c $100 d None of the above is correct ANS: C NAT: Analytic MSC: Applicative 43 DIF: REF: LOC: The role of money 30-2 TOP: Taxes | Capital gains For a given real interest rate, a decrease in the inflation rate would a decrease the after-tax real interest rate and so decrease saving b decrease the after-tax real interest rate and so increase saving c increase the after-tax real interest rate and so decrease saving d increase the after-tax real interest rate and so increase saving ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Taxes | Inflation | Real interest rate MSC: Applicative 44 Which of the following costs of inflation can be significant even if actual inflation and expected inflation are the same? a menu costs b inflation tax c shoeleather costs d All of the above are correct ANS: D NAT: Analytic MSC: Interpretive 45 TOP: Inflation costs DIF: REF: LOC: The role of money 30-2 TOP: Indexation | Inflation TOP: Inflation costs Which of the following is correct? Inflation a impedes financial markets in their role of allocating resources b reduces the purchasing power of the average consumer c generally increases after-tax real interest rates d is most costly when anticipated ANS: A NAT: Analytic MSC: Interpretive 47 30-2 Indexing the tax system to take into account the effects of inflation would by itself a mean that only real interest earnings are taxed b mean an end to taxing capital gains c mean an increase in average tax rates d All of the above are correct ANS: A NAT: Analytic MSC: Definitional 46 DIF: REF: LOC: The role of money DIF: REF: LOC: The role of money 30-2 Wealth is redistributed from debtors to creditors when inflation was expected to be a high and it turns out to be high b low and it turns out to be low c low and it turns out to be high d high and it turns out to be low ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Applicative 273 ❖ Chapter 30 /Money Growth and Inflation 48 Wealth is redistributed from creditors to debtors when inflation was expected to be a high and it turns out to be high b low and it turns out to be low c low and it turns out to be high d high and it turns out to be low ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Applicative 49 Wealth is redistributed from creditors to debtors when inflation is a high, whether it is expected or not b low, whether it is expected or not c unexpectedly high d unexpectedly low ANS: C DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Applicative 50 During the last tax year you lent money at a nominal rate of percent Actual inflation was percent, but people had been expecting 1.5 percent This difference between actual and expected inflation a transferred wealth from the borrower to you and caused your after-tax real interest rate to be 0.5 percentage points higher than what you had expected b transferred wealth from the borrower to you and caused your after-tax real interest rate to be more than 0.5 percentage points higher than what you had expected c transferred wealth from you to the borrower and caused your after-tax real interest rate to be 0.5 percentage points lower than what you had expected d transferred wealth from you to the borrower and caused your after-tax real interest rate to be more than 0.5 percentage points lower than what you had expected ANS: A DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Inflation | Real interest rate | Wealth redistribution 51 MSC: Applicative If the economy unexpectedly went from inflation to deflation, a both debtors and creditors would have reduced real wealth b both debtors and creditors would have increased real wealth c debtors would gain at the expense of creditors d creditors would gain at the expense of debtors ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Analytical 52 If inflation is higher than what was expected, a creditors receive a lower real interest rate than they had anticipated b creditors pay a lower real interest rate than they had anticipated c debtors receive a higher real interest rate than they had anticipated d debtors pay a higher real interest rate than they had anticipated ANS: A DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Analytical 53 Yvonne takes out a fixed-interest-rate loan and then inflation turns out to be higher than she had expected it to be The real interest rate she pays is a higher than she had expected, and the real value of the loan is higher than she had expected b higher than she had expected, and the real value of the loan is lower than she had expected c lower than she had expected, and the real value of the loan is higher than she had expected d lower then she had expected, and the real value of the loan is lower than she had expected ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Analytical Chapter 30 /Money Growth and Inflation ❖ 274 54 Marta lends money at a fixed interest rate and then inflation turns out to be higher than she had expected it to be The real interest rate she earns is a higher than she had expected, and the real value of the loan is higher than she had expected b higher than she had expected, and the real value of the loan is lower than she had expected c lower than she had expected, and the real value of the loan is higher than she had expected d lower then she had expected, and the real value of the loan is lower than she had expected ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Analytical 55 Tara deposits money into an account with a nominal interest rate of percent She expects inflation to be percent Her tax rate is 20 percent Tara’s after-tax real rate of interest a will be 2.8 percent if inflation turns out to be percent; it will be higher if inflation turns out to be higher than percent b will be 2.8 percent if inflation turns out to be percent; it will be lower if inflation turns out to be higher than percent c will be 3.2 percent if inflation turns out to be percent; it will be higher if inflation turns out to be higher than percent d will be 3.2 percent if inflation turns out to be percent; it will be lower if inflation turns out to be higher than percent ANS: B DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Taxes | Inflation | Real interest rate MSC: Analytical 56 If people had been expecting prices to rise but in fact prices fell, then who among the following would benefit? a lenders and people holding a lot of currency b lenders but not people holding a lot of currency c people holding a lot of currency but not lenders d neither lenders nor people holding a lot of currency ANS: A DIF: REF: 30-2 NAT: Analytic LOC: Unemployment and inflation TOP: Wealth redistribution | Inflation | Inflation tax MSC: 57 Definitional High and unexpected inflation entails a greater cost a for those who borrow than for those who save b for those who hold a little money than for those who hold a lot of money c for those whose wages increase by as much as inflation, than for those who are paid a fixed nominal wage d for savers in high income tax brackets than for savers in low income tax brackets ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Interpretive 58 High and unexpected inflation has a greater cost a for those who save than for those who borrow b for those who hold a little money than for those who hold a lot of money c for those whose wages increase by as much as inflation, than those who are paid a fixed nominal wage d for savers in low income tax brackets than for savers in high income tax brackets ANS: A DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Interpretive 59 Between 1880 and 1886, prices that were a lower than expected transferred wealth from creditors to debtors b lower than expected transferred wealth from debtors to creditors c higher than expected transferred wealth from creditors to debtors d higher than expected transferred wealth from debtors to creditors 275 ❖ Chapter 30 /Money Growth and Inflation ANS: B DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Interpretive 60 In 1898, prospectors on the Klondike River discovered gold This discovery caused an unexpected price level a decrease that benefited creditors at the expense of debtors b decrease that benefited debtors at the expense of creditors c increase that benefited creditors at the expense of debtors d increase that benefited debtors at the expense of creditors ANS: D DIF: REF: 30-2 NAT: Analytic LOC: The role of money TOP: Wealth redistribution | Inflation MSC: Interpretive Sec03 - Money Growth and Inflation - Conclusion MULTIPLE CHOICE In order to maintain stable prices, a central bank must a maintain low interest rates b keep unemployment low c tightly control the money supply d sell indexed bonds ANS: C NAT: Analytic MSC: Interpretive DIF: REF: LOC: The role of money 30-3 TOP: Inflation Which of the following is accurate? a Monetary policy is neutral in both the short run and the long run b Though monetary policy is neutral in the long run, it may have effects on real variables in the short run c Monetary policy has profound effects on real variables in both the short run and the long run d Monetary policy has profound effects on real variables in the long run, but is neutral in the short run ANS: B DIF: REF: NAT: Analytic LOC: The role of money TOP: Monetary policy | Monetary neutrality 30-3 MSC: Interpretive ... money rises 30- 1 TOP: Money market 241 ❖ Chapter 30 /Money Growth and Inflation ANS: A NAT: Analytic MSC: Interpretive 48 30- 1 TOP: Money market DIF: REF: LOC: The role of money 30- 1 TOP: Money... NAT: Analytic MSC: Applicative DIF: REF: 30- 1 LOC: Monetary and fiscal policy Chapter 30 /Money Growth and Inflation ❖ 244 Figure 30- 1 65 Refer to Figure 30- 1 If the money supply is MS2 and the... Applicative 18 30- 1 TOP: Quantity equation DIF: REF: LOC: The role of money 30- 1 TOP: Classical dichotomy DIF: REF: LOC: The role of money 30- 1 TOP: Velocity DIF: REF: LOC: The role of money 30- 1 TOP: