Queens College, CUNY - ECON 201

CHAPTER 8: Inflation

MULTIPLE CHOICE

1)The quote “Inflation is always and everywhere a monetary phenomenon” is attributed to:

1. 1. Karl Marx                                                d. Alan Greenspan
   2. Thomas Sargent                                      e.   David Ricardo
   3. Milton Friedman

2. The quote “Inflation is always and everywhere a fiscal phenomenon” is attributed to:
   1. Adam Smith                                            d. Alan Greenspan
   2. Thomas Sargent                                      e.   David Ricardo
   3. Karl Marx

3. Inflation is calculated as:
   1. the overall price level                             d. the difference in the price level
   2. the rate of change of the price level      e.   the percent change in output
   3. the percent change in the price level

4. If P_t is the price level in time t, inflation is calculated as:
   1. 1/P_t                                                          d.

      

b.

c.                               

5. When discussing inflation, we generally speak of it in terms of:
   1. the percent change in the consumer price index
   2. the percent change in the GDP deflator
   3. the level of the consumer price index
   4. one over the consumer price index
   5. the change in the producer price index

6. What contributed to Reagan’s defeat of Carter in the 1980 presidential election?
   1. double-digit inflation
   2. the low rate of unemployment
   3. the takeover of the U.S. embassy in Tehran, Iran
   4. Billy Carter’s beer
   5. Margaret Thatcher

7. In 1979, President Carter appointed           as chairman of the Board of Governors of the Federal Reserve to battle             .
   1. Greenspan; inflation                               d. Bernanke; unemployment
   2. Volcker; the Soviet Union                        e.   Powell; Ayatollah Khomeini
   3. Volcker; inflation

8. In 1979, in the face of rising competition in the fast food hamburger market, McDonald’s reduced the price of its cheeseburger to $0.43. If the CPI in 1979 was 37.2 and the CPI in 2005 was 100, what is the price of a 1979 cheeseburger in 2005 dollars?

a.   $0.77                                                       d.   $0.43

b.   $7.36                                                       e.   $0.14

c.                                $1.16

9. In 2007, the movie Transformers generated about $27.8 million on its opening day. In 1995, Batman Forever generated $20 million on its opening day. If the CPI in 2005 was 100, the CPI in 1995 was 78.0, and the CPI in 2007 was 106.2,         is the larger single-day grossing movie, with about

                million in revenues in 2005 dollars.

1. 1. Transformers; $27.8                               d. Transformers; $35.6
   2. Batman Forever; $35.6                           e.   Batman Forever; $27.8
   3. Transformers; $26.2

10. Today, the Wendy’s Junior Cheeseburger Deluxe is on the “Right Price Right Size” menu and is priced at $1.19. If the CPI in 1979 was 37.2 and the CPI in 2012 was 117.6, what is the price of a 2012 cheeseburger in 1979 dollars?

a.   $2.66                                                       d.   $0.38

b.   $1.07                                                       e.   $3.76

c.                                $1.01

11. Sometimes when discussing inflation, we use a measure of inflation that excludes    from its calculation because these prices tend to be volatile.
    1. commodity and energy prices                d. food and housing prices
    2. food and energy prices                           e.   energy and housing prices
    3. housing prices

12. In the United States, money is backed by:
    1. oil                                                            d. no physical commodity
    2. gold                                                         e.   None of these answers are correct.
    3. silver

13. Money that has no intrinsic value except as money is called       money.
    1. bonded                                                    d. intrinsic
    2. commodity                                              e.   None of these answers are correct.
    3. fiat

14. Silver, gold, and chocolate are examples of:
    1. fiat money                                               d. government money
    2. commodity money                                  e.   None of these answers are correct.
    3. backed money

15. A country on the silver standard uses:
    1. coins                                                        d. commodity money
    2. fiat money                                               e.   None of these answers are correct.
    3. bond money

16. Fiat money has value because:
    1. it is backed by gold                                 d. it is backed by silver
    2. people believe it has value                     e.   None of these answers are correct.
    3. it has intrinsic value

17. Fiat money has value because:
    1. people believe it has value                     d. it has intrinsic value
    2. it is backed by silver                               e.   it is a commodity
    3. it is backed by gold

18. Liquidity is a measure of:
    1. the monetary base
    2. how many coins are in circulation
    3. how quickly coins can be melted down
    4. how quickly an asset can be converted to currency
    5. the amount of reserves

19. The measure of money that includes demand deposits and currency only is called:
    1. M0                                                           d.   M1
    2. MZ                                                           e.   MB

1. 3. M2

20. M2 includes M1 and:
    1. large time deposits                                 d. long-term bonds
    2. overnight repurchase agreements         e.   gold reserves
    3. saving accounts

21. The monetary base consists of:
    1. reserves and currency
    2. M1 plus M2
    3. only M1
    4. gold reserves plus currency
    5. a country’s holdings of foreign and domestic currencies

22. In dollar amounts, which of the following is the largest?
    1. MB                                                          d. currency
    2. M2                                                           e.   demand deposits
    3. M1

23. Alternative forms of money include:
    1. frequent flier miles                                 d. PayPal
    2. gift cards                                                 e.   All of these answers are correct.
    3. debit cards

24. The velocity of money is:
    1. how quickly money can be printed
    2. how quickly individuals spend their income
    3. the average number of times a dollar is used in a transaction per year
    4. how many times individuals are paid per year
    5. None of these answers are correct.

25. 

    In the quantity equation, the value   is:
    1. real GDP                                                  d. the velocity of money
    2. nominal GDP                                           e.   real money
    3. aggregate expenditure

26. The velocity of money can be calculated from the quantity equation with:
    1. P_tY_t                                                           d.   P_tY_t

       

       /M_t
    2. P_tY_t

       

       M_t                                                       e.   M_t
    3. M_t

       

       /P_tY_t

27. Using the quantity equation, if, M_t = $1,000, P_t = 1.1, and Y_t = 100,000, then the velocity of money is: a.                                                               100,000  d. 9.09

b.   0.09                                                         e.   0.11

c.                                110

28. Using the quantity equation, if M_t = $1,000, P_t = 1.1, and V_t = 11, then real GDP is: a.   $100,000                                                 d. $909.19

b.   $0.01                                                       e.   $826.45

c.                                $100

29. The quantity theory states that the nominal GDP is equal to:
    1. the real GDP
    2. the number of dollars in circulation
    3. the velocity of money
    4. the effective amount of money used in purchases
    5. velocity times real GDP

30. According to the classical dichotomy, in the long run there is:
    1. accelerating economic growth
    2. perfect connectivity between the nominal and real sides of the economy
    3. complete separation of the nominal and real sides of the economy
    4. no growth after the economy reaches the steady state
    5. zero inflation

31. Which of the following has NO effect on long-run economic growth?
    1. a store of gold                                         d.   investment
    2. money                                                     e.   population
    3. productivity

32. In the quantity theory of money, the:
    1. price level is exogenous
    2. real GDP, velocity, and money supply are endogenous

1. 3. real GDP and money supply are endogenous
   4. real GDP, velocity, and money supply are exogenous
   5. real GDP is endogenous

33. In the simple quantity theory of money, the supply of money is:
    1. exogenous
    2. a policy variable
    3. determined by the relationship between output and the price level
    4. endogenous
    5. equal to the supply of gold reserves

34. According to the quantity theory of money, the price level is:
    1. exogenous
    2. determined by the money supply only
    3. determined by the ratio of the effective quantity of money to the volume of goods
    4. indeterminate in the long run
    5. determined by the volume of goods produced

35. According to the quantity theory of money, the price level can be written as:

a.                                                                  

b.

c.                               

36. The essence of the quantity theory of money is that:
    1. the price level is indeterminate
    2. in the long run, the only determinant of the price level is the money supply
    3. in the long run, a key determinant of the price level is the money supply
    4. only the central bank knows what the price level is
    5. money cannot pin down the price level

37. Using the quantity theory of money, we can calculate inflation using      , under the assumption that                     .

    1. 

       ; velocity is constant

    2. 

       ; percent change in velocity always equals one

    3. 

       ; velocity is constant

    4. 

       ; velocity is variable

1. 5. 

      ; velocity is constant

38. If long-run real GDP growth is determined by real changes in the economy, the quantity theory of money implies that:
    1. changes in the money growth rate lead one-for-one to changes in the inflation rate in the long run
    2. changes in the money growth rate lead one-for-one to changes in the inflation rate but only in the short run
    3. changes in velocity lead one-for-one to changes in the inflation rate
    4. changes in the money growth rate lead to a greater than one-for-one change in the inflation rate in the long run
    5. None of these answers are correct.

39. You are the head of the central bank and you want to maintain 2 percent long-run inflation, using the quantity theory of money. If the real GDP growth is 4 percent and velocity is constant, you suggest a:
    1. 6 percent interest rate                           d. 0 percent money supply growth
    2. 6 percent money supply growth             e.   2 percent interest rate
    3. 2 percent money supply growth

40. If the real GDP growth is 4 percent per year, the money growth rate is 6 percent, and velocity is constant, using the quantity theory, the inflation rate is:
    1. 6 percent                                                 d. 2 percent
    2. 4 percent                                                 e.   ?4 percent
    3. ?2 percent

41. If the real GDP growth is 6 percent per year, the money growth rate is 4 percent, and velocity is constant, using the quantity theory, the inflation rate is:
    1. 4 percent                                                 d. 6 percent
    2. ?2 percent                                                 e.   ?4 percent
    3. 2 percent

42. You are the head of the central bank and you want to maintain 2 percent long-run inflation. Using the quantity theory of money, if real GDP growth is 4 percent and velocity is constant, you suggest a:
    1. 4 percent money supply growth             d. 0 percent money supply growth
    2. 6 percent interest rate                           e.   None of these answers are correct.
    3. 2 percent money supply growth

43. The implications of the quantity theory of money are the main basis for which of the following quotes?
    1. “Inflation is always zero in the long run.”
    2. “Inflation is always and everywhere a fiscal phenomenon.”
    3. “Inflation is always and everywhere a monetary phenomenon.”
    4. “Velocity growth should be equal to 2 percent in the long run.”
    5. “Velocity is always constant.”

44. The data presented in Figure 8.1 confirm that the relationship between inflation and money growth is:
    1. positive, as suggested by the Fisher equation
    2. positive, as suggested by money neutrality
    3. positive, as suggested by the quantity theory of money
    4. negative, as suggested by the quantity theory of money
    5. None of these answers are correct.

45. The proposition that changes in money have no real effect on the economy and affect only prices is called:
    1. inflation                                                   d. the neutrality of money
    2. the classical dichotomy                          e.   the quantity theory
    3. the quantity equation

46. Empirically, a large amount of evidence suggests that money neutrality    , but changes in money supply              .
    1. holds in the short run; do not affect nominal variables
    2. does not hold in the long run; can have real effects in the short run
    3. holds in the short run; can have real effects in the long run
    4. holds in the long run; can have real effects in the short run
    5. does not hold in the long run; have an effect on unemployment in the long run

47. The nominal interest rate is:
    1. the interest rate not adjusted for inflation
    2. the “advertised” interest rate
    3. a description of the return in units of currency
    4. All of these answers are correct.
    5. None of these answers are correct.

48. The real interest rate is:
    1. the interest rate not adjusted for inflation
    2. the “advertised” interest rate
    3. a description of the return in units of currency
    4. All of these answers are correct.
    5. None of these answers are correct.

49. The real interest rate describes:
    1. the net return to government bonds
    2. the rate of return adjusted for inflation
    3. the rate of return in units of a currency
    4. the return with an interest rate equal to zero
    5. the rate of return in real goods

50. Let r denote the real interest rate and i denote the nominal interest rate; these two interest rates are related by:

    1. 

       

       d.

    2. 

       e.   None of these answers are correct.

51. 

    Let r denote the real interest rate, i denote the nominal interest rate, and ? denote the rate of inflation. The equation                    is called:
    1. the money supply                                    d. the quantity theory of money
    2. the quantity equation                             e.   money neutrality
    3. the Fisher equation

52. Suppose you put $100 dollars in the bank on January 1, 2013. If the annual nominal interest rate is 5 percent and the inflation rate is 5 percent, you will be able to buy     worth of goods on January 1, 2014.

a.   $90                                                          d. $105

b.   $110                                                        e.   $95

c.                                $100

53. Suppose you put $100 dollars in the bank on January 1, 2013. If the annual nominal interest rate is 5 percent and the inflation rate is 2 percent, you will be able to buy     worth of goods on January 1, 2014.

a.   $93                                                          d. $105

b.   $107                                                        e.   $99

c.                                $103

54. Suppose you put $100 dollars in the bank on January 1, 2013. If the annual nominal interest rate is 2 percent and the inflation rate is 5 percent, you will be able to buy     worth of goods on January 1, 2014.

a.   $95                                                          d. $103

b.   $102                                                        e.   ?$3

c.                                $97

55. If the inflation rate is larger than the nominal interest rate:
    1. unemployment rises
    2. the real interest rate is zero
    3. the real interest rate is negative
    4. the real interest rate is larger than the nominal interest rate
    5. Not enough information is given.

56. Compared to the nominal interest rate, the real interest rate is:
    1. negative                                                  d. relatively stable
    2. always smaller                                        e.   relatively volatile
    3. always greater than zero

57. If the real interest rate is negative, it must mean that:
    1. in the short run, bond rates can be very volatile
    2. in the short run, the real interest rate equals the marginal product of capital
    3. in the short run, the real interest rate can deviate from the marginal product of capital
    4. it is difficult to predict long-term interest rates
    5. there is no relationship between long- and short-term interest rates

58. Practically, the real interest rate is equal to:
    1. a savings account                                    d. the return to stock markets
    2. the rate of return to long-term bonds    e.   the return to housing

1. 3. the marginal product of capital

59. A risk a bank takes on by offering long-term fixed interest rate loans is:
    1. the loss of real returns due to anticipated inflation
    2. the gain that could be made from offering short-term loans
    3. the loss of real returns due to an unexpected inflation surprise
    4. the gains that could have been made if the money were invested in an alternative asset
    5. the loss of customers wanting flexible interest loans

60. When calculating fixed retirement payments, it is important not to forget:
    1. changes in flexible interest rates
    2. the decline in the payment’s value due to inflation
    3. the increase in the payment’s value due to inflation
    4. rates of return in other markets
    5. the price of tea in China

61. By purchasing a fixed-rate 30-year mortgage, inflation risk is:
    1. eradicated
    2. spread equally to the borrower and lender
    3. passed from the lender to the borrower
    4. passed from the borrower to the lender
    5. borne by the government

62. If you decide to buy a house with an adjustable-rate mortgage (ARM), you are:
    1. exposing yourself to inflation risk
    2. reducing your inflation risk
    3. passing inflation risk to the lender
    4. taking on some of the lender’s inflation risk
    5. increasing your mortgage payment

63. Negative inflationary surprises lead to:
    1. an increase in the real interest rate
    2. a redistribution of wealth from borrowers to lenders
    3. a decline in the nominal interest rate
    4. a decline in inflation risk for lenders
    5. a redistribution of wealth from lenders to borrowers

64. If income tax rates are based on nominal income, as inflation increases, taxpayers will see:

1. 1. an increase in their real incomes
   2. their taxes fall as their incomes fall
   3. their taxes rise even though their real incomes are falling
   4. an increase in the nominal income
   5. their taxes fall even though their real incomes are rising

65. If some goods’ prices adjust more quickly than others, there is:
    1. a perfect short-run allocation of resources
    2. a short-run misallocation of resources
    3. no inflation
    4. a hyperinflation
    5. a deflation

66. Inflation                price volatility and              allocative efficiency.
    1. decreases; increases                               d. increases; decreases
    2. decreases; leaves unchanged                 e.   leaves unchanged; increases
    3. increases; leaves unchanged

67. During times of high inflation, people hold           and must incur             .
    1. less savings; lower interest rates
    2. more money; lower interest rates
    3. less money; higher shoe-leather costs
    4. more savings; shoe-leather costs
    5. less savings; higher transaction costs

68. The costs associated with changing prices in times of inflation are called:
    1. inflation risks                                          d. shoe-leather costs
    2. price staggering                                      e.   menu costs
    3. transaction costs

69. One problem with unexpected changes in inflation is that:
    1. it steadily erodes real income
    2. it often comes in surprising and unpredictable ways
    3. nominal interest rates are not indexed to inflation
    4. fixed-rate mortgages are not adjusted for inflation
    5. price staggering occurs

70. To minimize what was believed to be a wage-price spiral, the       administration             .

1. 1. Reagan; increased corporate income
   2. Carter; increased interest rates
   3. Clinton; released oil from the strategic reserves
   4. first Bush; increased taxes
   5. Nixon; imposed price controls

71. The price controls imposed by the Nixon administration lasted for:

72. With unanticipated inflation:
    1. creditors are hurt unless they have an indexed contract, because they get less than they expected in real terms
    2. debtors with an indexed contract are hurt, because they pay more than they contracted for in nominal terms
    3. debtors with an unindexed contract lose, because they pay exactly what they contracted for in nominal terms
    4. creditors with indexed contracts gain, because they receive more than they contracted for in nominal terms
    5. debtors with an indexed contract are hurt, because they pay more than they contracted for in real terms

73. According to the government’s budget constraint, if the government spends more than it generates in taxes, it can raise revenues by:
    1. printing money                                       d. privatizating
    2. decreasing its debt                                 e.   increasing interest rates
    3. lowering interest rates

74. The right to seignorage is the right to:
    1. make coins                                              d. borrow from the public
    2. raise tax revenues                                  e.   raise an army
    3. print money

75. The revenue governments obtain from printing money is called:
    1. issued debt                                              d. government expenditures
    2. the inflation tax                                      e.   None of these answers are correct.
    3. raised taxes

76. With an inflation tax:
    1. everybody loses
    2. all individuals in an economy feel the pressures equitably
    3. there is a redistribution of income from owners of real assets to income earners
    4. there is a redistribution of income from income earners to owners of real assets
    5. the government has a lot of debt to repay

77. A government that relies on seignorage to finance excess government expenditures is the foundation for the following quote:
    1. “Inflation is always zero in the long run.”
    2. “Inflation is always and everywhere a monetary phenomenon.”
    3. “Inflation is always and everywhere a fiscal phenomenon.”
    4. “Velocity growth should be equal to 2 percent in the long run.”
    5. “Velocity is always constant.”

78.                 prevent(s) governments from being tempted to use seignorage excessively.
    1. Gold reserves                                          d. Future generations
    2. The power of bond markets                   e.   Central bank independence
    3. The government budget constraint

79. According to the quantity equation, the cure for hyperinflation is:
    1. higher taxes                                            d. All of these answers are correct.
    2. reducing government spending              e.   None of these answers are correct.
    3. reducing money growth

80. The cure for hyperinflation is:
    1. reducing money growth                         d. seignorage
    2. maintaining government spending        e.   All of these answers are correct.
    3. lower taxes

81. In the text, the country that experienced the highest inflation rate in 1990 was:

82. The coordination problem is difficult to solve because:
    1. policymakers cannot make unified decisions

1. 2. aggregate price-setting behavior has built-in inflation inertia
   3. individual price-setting behavior economywide has built-in inflation inertia
   4. central banks are controlled by many different interests
   5. All of these answers are correct.

83. If all price setters are not convinced that high inflation rates will end soon, there is:
    1. price staggering
    2. a transfer of wealth from one group to another
    3. substantial menu costs
    4. a coordination problem
    5. negative real interest rates

TRUE/FALSE

1. Economists often use a rate of inflation that is calculated using all goods EXCEPT vehicles and housing, because prices for these goods are relatively volatile.

2. The U.S. dollar is backed by the belief that it has value.

3. Short-term treasury bills are the most liquid form of asset.

4. M1 consists of savings and money market accounts.

5. The velocity of money is defined as the average number of times a dollar is used in a transaction over the course of year.

6. In the quantity equation, the value P_tY_t is the real GDP.

7. According to the quantity theory of money, the price level is determined by the ratio of the effective quantity of money to the volume of goods.

8. Money neutrality is the proposition that changes in money have no real effect on the economy.

9. The costs associated with changing prices are called menu costs.

10. An implication of the quantity theory of money is that money growth rates have a less than one-to-one relationship with inflation.

11. If the inflation rate is higher than the nominal interest rate, the real interest rate is positive.

12. Compared to the real interest rate, the nominal interest rate has been relatively constant, moving with changes in inflation.

13. If the real interest rate is less than zero, it implies that the real interest rate deviates from the marginal product of capital in the short run.

14. If you put $100 in the bank for one year at an annual nominal interest rate of 5 percent and yearly inflation is running at 7 percent, you will be able to buy $105 worth of goods when you pull it out of your account.

15. If all goods’ prices adjust simultaneously, there will be a short-term misallocation of resources.

16. If a bank offers you a 30-year fixed-rate mortgage, it is passing inflation risk over to you.

17. Inflationary surprises transfer wealth from lenders to borrowers.

18. The right to seignorage is the right to apply income taxes.

19. In the United States, decisions about monetary policy are conducted by the Federal Reserve, which is likely to lower income taxes.

20. In times of high inflation, shoe-leather costs rise.

21. The Federal Reserve believed that the productivity slowdown in the 1970s was a long-lived recession and therefore increased the supply of money.

22. The high rate of inflation in the United States in the late 1970s and early 1980s was due to high inflation taxes.

SHORT ANSWER

(Source: U.S. Bureau of Labor Statistics)

1. Considering the end-of-year CPI data in Table 8.1:
   1. Calculate the rate of inflation between 1970 and 1975 and between 1995 and 2000.
   2. Calculate the average rate of inflation for 1970–1975 and 1970–1980.
   3. Calculate the average rate of inflation for 2000–2012 and 2005? 2010.
   4. Briefly comment on your results.

2. Briefly discuss what makes up the monetary base, M1, and M2.

3. Write down the quantity equation in growth terms, and identify each variable.

1. 1. According to the quantity theory of money, what determines the long-run rate of inflation?