Often, economic "experts" advise developing nations to prohibit foreign ownership of domestic assets. According to the rational expectations school, when monetary policy makers do exactly what is expected of them, their efforts to stimulate the economy will have no effect either on output or employment. In general, we would expect those who favor a passive approach to policy to believe in, a reduction in unemployment comes at the expense of higher inflation, According to the rational expectations school, people base their expectations about inflation on, According to the passive policy maker's position, an expansionary gap will be eliminated because, the short-run aggregate supply will shift to the left, In Exhibit 17-3, the natural rate of unemployment is, 4 percent because it is on the long-run curve, Those of the rational expectations school, favor monetary rules so that workers and firms do not get any unanticipated surprises from the Fed. The policy surprise may be a To determine how the standard‐of‐living of the average person has changed over time the appropriate measure is the. What method would the Fed likely use to implement this change? Rational expectations has been a working assumption in recent studies that try to explain how monetary and fiscal authorities can retain (or lose) "good reputations" for their conduct of policy. Which of the following would correspond to movement downward along a short-run Phillips curve? c) a expansionary monetary policy. Economists of the rational expectations school believe that expansionary monetary policy is fully effective only if, According to those who favor a passive approach to policy, a recessionary gap will be eliminated because. The consumer price index was 160 ten years ago and 220 this year. In the event of a recession, which of the following is the most likely policy stance of those who advocate a passive approach to economic policy? The early Phillips curve showed a tradeoff between unemployment and inflation because it was drawn for a period in which the main source of instability was aggregate demand. The theory of rational expectations concludes that: A. the public's expectations can influence the outcome of monetary policy, but not of fiscal policy. According to the adaptive expectations hypothesis, at the beginning of period 3, decision makers would expect inflation during period 3 to be, According to the Rational Expectations hypothesis, at the beginnig of period 3, decision makers will expect inflation during period 3 to be, In the past year, the value of the Euro has increased from $1.35 to $1.54. 24 R.J. Barro, Rational expectations and the role of monetary policy existence of an active stabilization policy motivates individuals to reduce expenditures that are aimed at augmenting their information sets. According to the theory of rational expectations, individuals will respond to expansionary monetary policy by Predicting a higher rate of inflation "A consistent countercyclical policy has no effect on employment and output, since individuals will recognize those policies as … This is caused in part by, all the above are correct; increased spending on entitlement programs, the bailout of financial firms passed last fall under the leadership of republicans, the fiscal stimulus package passed this spring under the direction of democrats, The proponents of rational expectations believe that, the inflationary side effects of expansionary policies are anticipated quickly and, Evaluate the following statements: "Every time someone in Idaho buys an automobile made in Michigan, Idaho is worse off. During recent times, the U.S. has been running a current account deficit. Proponents of all forms of expectations generally agree, underprediction of inflation generally leads to lower unemployment. As shown in Exhibit 17-2, if people behave according to adaptive expectations theory, an increase in the aggregate demand curve from AD1 to AD2 will cause the economy to move: Rational Expectations Theory In economics, a theory stating that economic actors make decisions based on their expectations for the future, which are based on their observations and past experiences. Suppose that the Federal Reserve significantly increases the growth rate of the money supply. In general, the faster inflationary expectations adjust, the less macro policy can influence unemployment. If the monetary authorities follow policies that keep the annual rate of inflation steady and low, which of the following is most likely to occur? Which of the following explains an upward sloping short‐run aggregate supply curve? b. useless in the short run. The inflation associated with the oil embargoes of the 1970s illustrated the __________ of the downward-sloping Phillips curve in the long run, as unemployment __________. If an improvement in education in the United States increases effective labor, this. Answer:D 136.According to the theory of rational expectations, individuals will respond to expansionary monetary policy by: A.predicting a lower rate of inflation. d. None of the answers are correct. I is true in the short run and II is true in the long run. Suppose a recession surprises economic forecasters, who did not see it coming. capital stock and natural resources; property rights and regulations. Throughout this series of computer-assisted learning modules dealing with small open economy equilibrium we have alternated between two crude assumptions about wage and price level adjustment. If prices and wages are not flexible, an adverse supply shock is most likely to be followed by, For those who favor an active approach, public policy changes are necessary to cure a recessionary gap because, real wages must fall through price increases rather than waiting for money wages to fall, The inflation associated with the oil embargoes of the 1970s resulted in, increased unemployment because aggregate supply fell, When policy makers have an incentive to announce one policy to shape expectations but then pursue a different policy once those expectations have been formed and acted on, there is. Some of those who favor a passive approach to policy disapprove of government intervention in the economy because they think government policy makers do not know which policy is correct. If the price level increases by more than expected, output can be expected to decrease as a result. According to those who favor a passive approach to policy, how will the economy shown in Exhibit 17-2 attain equilibrium at potential output? Which type of lag is that? the decision-making lag and the implementation lag. As a consequence, there is instant inflation without much effect on real variables such as … an expansion in output and a decrease in prices. This means that the Euro has, appreciated, and Europeans now find U.S. goods cheaper. according to rational expectations theory, if the gov policies in a country are anticipated, then, there is nothing gov can do, even in the short run, to reduce the ecos unemployment rate. As shown in Figure 15-3, if people behave according to rational expectations theory, an increase in the aggregate demand curve from AD1 to AD2 will cause the price level to … c) It would increase aggregate output in both the short run and the long run. If in 2005, Fed officials announce again that an expansion is planned, the most likely result is that, there will be more uncertainty about the Fed following through on the policies it announces. B) effective only if it is unexpected. made more difficult if the natural unemployment rate cannot be easily calculated, there is an inverse relationship between inflation and unemployment, The unemployment rate can remain below the natural rate, but only, with a continuously increasing inflation rate, Rational excectations is a school of thought that argues people form expectations based on, If inflationary expectations increase, we can infer that, the economy is not on the long-run Phillips curve. For example, if people know that expansionary fiscal or monetary policy will cause inflation in the long run, they will factor that into their expectations. 133. D. incorrectly forecasting what will happen to the price level and employment. The unemployment rate is probably above the natural rate. Explain how the theory of rational expectations means that demand management policy is ineffective Adaptive versus Rational Expectations The natural rate hypothesis, which we learned about in an earlier section, argues that while there may be a tradeoff between inflation and unemployment in the short run, there is no tradeoff in the long run. In the 1992 presidential campaign, candidate Al Gore advocated a more active role for government in economic policy than did candidate George W. Bush. Rational Expectations and Monetary Policy. Recently the U.S. government sent tax rebate checks and the Fed increased the money supply. If inflation turns out to be only 4 percent, which of the following is most likely? 132. According to those who favor a passive approach to policy, how will the economy shown in Exhibit 17-1 attain equilibrium at potential output? Similarly, the expected price level at the beginning of the period is expected to hold till the end of the period. If it increases production of food by 2 units (to a total of 6 units of food), clothing production will. Questio n 18 1 / 1 point According to the quantity theory, if constant growth in the money supply is combined with fluctuating velocity, which of the following is most likely to result? Both are implications of the rational expectations hypothesis, which assumes that individuals form expectations about the future based on the information available to them, and that they act on those expectations. During the 1970s in the United States, inflation rates were _______________ by historical standards and the unemployment rate was _______________ by historical standards. Although individual forecasts can be very wide of the mark, actual economic outcomes do not vary in a predictable way from participants’ aggregate predictions or expectations. B.predicting a higher rate of inflation. prolonged high rates of unemployment during the 1930s. According to adaptive expectations theory, expansionary monetary and fiscal policies to reduce the unemployment rate are a. useless in the long run. According to rational expectations, monetary policy is: A) always effective. Economic growth around the globe is positively related to. If an unanticipated reduction in aggregate demand results in output at less than the full employment output, resource prices fall eventually, directing the economy back to full employment, When there is an increase in the expected inflation rate, the, short-run Phillips curve shifts upward (to the right), The vertical long‐run aggregate supply curve reflects the fact that in the long run, an increase in the price level, does not alter the economy's maximum sustainable rate of output, The big mistake that Samuelson and Solow made in their application of the Phillips Curve was to implicitly assume inflation expectations, Keynesian solutions to the Great Depression focused primarily on. incorrect because the real income of the economy is limited by the economy's resources, technology, and institutions. The active approach to monetary policy involves predetermined rules that are followed virtually without exception. B. the public's expectations can influence the outcome of fiscal policy, but not of monetary policy. People respond to such rates by spending less time producing and more time protecting. A basic example of rational expectations theory is a situation in which a consumer delays buying a certain good because, based on his/her observations and experiences, he/she believes that the price will be less expensive in a month. What is the opportunity cost of producing one unit of food in China? Before discovering that the short-run Phillips curve does not show the true long-run situation, policy makers were successful in trying to bring the economy to the zero-inflation, zero-unemployment point on the short-run curve. Best ECO 3203 Ch 18 Stabilization Policy Flashcards | Quizlet Real wages will fall shifting the SRAS curve to the right. The rational expectations theory clashes with other theories of how we look into the future, such as adaptive expectations, which says that we base our predictions on past and changing trends. C.predicting no change in the rate of inflation. If the effects of contractionary monetary policy are fully anticipated by decision makers, the policy shifts. According to the theory of rational expectations, individuals will respond to expansionary monetary policy by: A. See the answer. both countries would gain if Vietnam traded food for China's clothing. How does aggregate demand change if foreign incomes increase and the dollar appreciates? Which of the following pairs of lags are typically shorter for monetary policy than for fiscal policy? According to the rational expectations theory, if expansionary macroeconomic policy is to work in the short-run, a "policy surprise" must occur. C) ineffective compared to fiscal policy. decrease government spending and/or raise taxes. Robert Emerson Lucas Jr., an American economist at the University of Chicago, who is … Time required __________ is not a time lag associated with using discretionary policy to correct an economic problem. Expectations Adaptive: Gordon rejects the logic of the Ratex hypothesis entirely. Chapter 36 - Current Issues in Macro Theory and Policy 98. In the long run, how would an active approach to a recessionary gap differ from a passive approach to policy? lead to a budget deficit during a recession. an unemployment rate that is at or near the natural rate of unemployment because the actual rate of inflation will not be much different than what people expect, The tax reform of 2001, ushered through Congress by President Bush, included which of the following provisions, all above are correct; tax cuts for rich, tax cuts for poor, tax rebates, The U.S. federal budget deficit for this year is more than four times any previous deficit. The real GDP figures reflect changes in the quantity of output and not changes in the, When an economy is producing at full employment output (Y = Y*), One important contribution of Solow's first growth model is the importance of, Diminishing marginal productivity of capital. If the government increase money supply when expectations of inflation are low, they may be able to reduce the real value of government debt. In other words, according to the rational expectations theory, the intended effect of expansionary monetary policy on investment, real output and employment does not materialize. The theory of rational expectations is consistent with which statement? These statements are incorrect because voluntary trade helps both sides. According to there is a short-run inverse relationship between inflation and unemployment rates. Which of the following is true regarding these deficits? This statement most closely reflects the published views of. According to those who favor an active approach to policy, where will the economy in Exhibit 17-1 end up when it achieves its potential output? The main policy conclusion of the rational expectations school is, neither monetary nor fiscal policy can be helpful if firms and households correctly anticipate the plans of policy makers, Given the expected price level, policies for reaching potential GDP will work best if the money supply is, exactly the size that makes prices equal to the prices people expected to prevail. According to the theory of rational expectations, this same idea can be applied to inflation forecasts. If the Federal Reserve significantly raises monetary growth (and this is unanticipated), economic theory teaches that interest rates. An economy in which actual GDP exceeds potential GDP means that, self-correcting forces will shift the SRAS curve to the left, Suppose that in 2004 the Fed announced a policy of rapid growth in the money supply, but then put the brakes on money expansion without any announcement. Why is it important to use real rather than nominal GDP figures when making comparisons of output across time periods? In other words, according to the rational expectations theory, the intended effect of expansionary monetary policy on … d) a contractionary monetary policy. An expansionary fiscal policy or an easy monetary policy, designed to reduce unemployment, is correctly perceived to lead to higher prices; in consequence, private spending accelerates. The rational expectations theory is a concept and theory used in macroeconomics. The primary focus of this proposal is, The goal of supply side fiscal policy is to, implement institutions that lead to increases in resources or technological advancement, In the Keynesian view of the macroeconomy, increased savings. An important implication of the natural rate hypothesis is that regardless of concerns about __________, the government policy that results in __________ is generally the optimal long-run policy. Who received the higher real starting salary? A major problem in the conduct of macroeconomic policy is the time it takes to recognize that the economy is experiencing a problem. Some economists believe that in the long run the unemployment rate is independent of the inflation rate and so the Phillips curve becomes a vertical line. Thus even if expectations are rational, monetary or fiscal policy can influence production and unemployment in the short-run. The aggregate demand curve shifts leftward, moving down along a short-run aggregate supply curve. Your friend graduated from college 10 years ago and started work at a salary of $40,000. Which of the following is true of high and variable rates of inflation? RATIONAL EXPECTATION MODEL: THE EFFECT OF EXPANSIONARY MONETARY POLICY The effect of a fully-anticipated expansion in money supply, say from M 0 to M 1 can be explained as under. If the money supply increases by 7 percent, velocity (of money) does not change, and real GDP grows by 2.2 percent, the price level. The theory of rational expectations was first proposed by John F. Muth of Indiana University in the early 1960s. deflation is a potential future danger, and the Fed should conduct expansionary policy. He used the term to describe the many economic situations in which the outcome depends partly on what people expect to happen. Suppose we observe several years of falling inflation rates for an economy. You graduate this year and start to work for $50,000. 3. 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