When the overall price level is rising, nominal interest rates tend to be:
Answer(s): C
Choice "c" is correct. The relationship between nominal interest rates and inflation can be seen by rearranging the equation for real interest rates as follows:Nominal Interest Rate = Real Interest Rate + InflationThus, if real interest rates do not change, a 1% increase in the inflation rate will lead to a 1% increase in nominal interest rates.
Inflation can be caused by:
Answer(s): D
Choice "d" is correct. Both an increase in aggregate demand and a decrease in aggregate supply can cause inflation.Choice "a" is incorrect. While an increase in aggregate demand can cause inflation, it is not the only cause of inflation.Choice "b" is incorrect. An increase in aggregate supply would lower the overall price level, not increase the overall price level.Choice "c" is incorrect. A decrease in aggregate demand would lower the overall price level, not increase the overall price level.
To address the problem of a recession, the Federal Reserve Bank most likely would take which of the following actions?
Answer(s): A
Choice "a" is correct. During a recession, real GDP has fallen and unemployment has risen. To stimulate the economy, the Fed can lower the discount rate. This causes the money supply to increase, which, in turn, causes aggregate demand to shift right. As a result, real GDP would increase and unemployment would decrease.Choice "b" is incorrect. If the Fed sells U.S. government bonds in the open market, the money supply will decrease. This causes aggregate demand to shift left. As a result, real GDP would decrease and unemployment would increase.Choice "c" is incorrect. Increasing the federal funds rate would increase interest rates. Higher interest rates cause the aggregate demand curve to shift left. As a result, real GDP would decrease and unemployment would increase.Choice "d" is incorrect. An increase in the required reserve ratio causes the money supply to decrease.This causes aggregate demand to shift left. As a result, real GDP would decrease and unemployment would increase.
Which of the following actions is the acknowledged preventive measure for a period of deflation?
Answer(s): B
Choice "b" is correct. Deflation is a general decline in the overall price level (i.e., when the inflation rate is negative). Increasing the money supply causes the overall price level to rise. As a result, it helps eliminate deflation.Choice "a" is incorrect. Increasing interest rates causes aggregate demand to shift left. As a result, the aggregate price level will fall even further. This will exasperate deflation.Choice "c" is not wrong but it is not as good an answer as "b". A decrease in interest rates causes the aggregate demand curve to shift right. As a result, the aggregate price level will rise. This helps eliminate deflation. However, there are times when interest rates are already so low that lowering interest rates is not an option. Thus, the preferred or "acknowledged" preventative measure for deflation is increasing the money supply.Choice "d" is incorrect. Decreasing the money supply causes the overall price level to fall. This would obviously exasperate deflation.
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