ECS 4861 Advanced macro economics -

1. Which of the following is (are) an essential feature of new classical economics?

[1] Imperfect information.

[2] Continuous market clearing.

[3] Perfectly flexible prices and wages.

[4] Rational expectations.

[5] All of the above.

2. Which of the following is (are) a feature of Lucas's theory of the business cycle?

[1] Voluntary unemployment.

[2] Adaptive expectations.

[3] Only announced changes in monetary policy can have an effect on real output.

[4] Only expected changes in inflation lead to changes in employment and output.

[5] None of the above.

3. Which of the following is a feature of new classical economics but not orthodox mone-tarism?

[1] The possibility of a short-run trade-off between inflation and unemployment.

[2] A vertical long-run aggregate supply curve at the natural rate of unemployment.

[3] Continuous market clearing equilibrium.

[4] Short-run disequilibrium in the labour market.

[5] Long-run neutrality of money.

4. In the context of new classical models, Walrasian general equilibrium means that:

[1] demand always equals supply in all markets.

[2] voluntary unemployment cannot occur.

[3] no trade-off between inflation and unemployment is possible.

[4] money is always neutral.

[5] All of the above.

5. The weak version of the rational expectations hypothesis implies that:

[1] expectations change only if new relevant information becomes available.

[2] forecasts of the inflation rate may be biased in a certain direction because workers,

consumers and firms do not have complete knowledge of how the economy works.

[3] no information is ignored in forming expectations.

[4] there is serial correlation of forecast errors over time.

[5] None of the above.

6. The weak version of the rational expectations hypothesis implies that workers, consumers

and firms:

[1] can make systematic forecasting mistakes.

[2] know the true model of the economy (or relevant part thereof).

[3] have perfect foresight.

[4] know the full probability distribution of outcomes following relevant events (such as a

change in monetary policy).

[5] None of the above.

7. The strong version of the rational expectations hypothesis implies that workers, consumers

and firms:

[1] make choices based on perfect information.

[2] do not make forecast errors based on publicly available information.

[3] have perfect foresight.

[4] form expectations that coincide with the outcomes predicted by the relevant model of

the economy.

[5] All of the above.

8. Which of the following describes how people acquire information according to the rational

expectations hypothesis?

[1] They ignore historic data.

[2] They ignore publicly available information.

[3] They search for information up to the point where the expected marginal cost of

further information equals the expected marginal value thereof.

[4] All of the above.

[5] None of the above.

9. The new classical assumption of continuous market clearing implies that:

[1] demand and supply are always equal in all markets.

[2] there are never any unexploited opportunities to increase profits or utility.

[3] both the producer and consumer surplus are maximized.

[4] involuntary unemployment can never occur.

[5] All of the above.

10. In terms of Lucas's intertemporal substitution model of the labour market:

[1] workers choose how much they want to work based on changes in real wages.

[2] lower real wages lead workers to allocate more time to leisure now and more time to

work in the future.

[3] differences between the demand for and supply of labour are quickly eliminated by

changes in flexible wages and prices.

[4] All of the above.

[5] None of the above.

11. Lucas's "surprise" supply function implies that:

[1] firms may mistake a change in the price level for a change in the relative price of

their own goods.

[2] output and unemployment can deviate from their natural rates in the long run.

[3] output is less elastic, the lower has been the variability of the price level in the past.

[4] All of the above.

[5] None of the above.

12. Lucas's monetary theory of the business cycle:

[1] helps to explain why output and inflation are pro-cyclical.

[2] assumes that economic agents have imperfect information about the economy.

[3] helps to explain why output and inflation tend to move in the same direction over the

course of the business cycle.

[4] relies on the signal extraction problem.

[5] All of the above.

13. According to Lucas's theory of the business cycle, an expansionary monetary policy will:

[1] only effect the level of output and unemployment if it is unanticipated.

[2] only effect the natural rate of unemployment if it is unanticipated.

[3] have a greater effect on output, the less is the historic deviation of the actual from the

expected price level.

[4] All of the above.

[5] None of the above.

14. Which of the following is (are) a policy implication(s) of new classical theory?

[1] Only transparent and well communicated changes in monetary policy will have any

effect on output and unemployment in the short run.

[2] Only a rule based framework for monetary policy (such as inflation targeting) can

have any effect on output and unemployment in the short run.

[3] The more credible is the central bank, the greater is the output sacrifice necessary to

bring down inflation.

[4] Fiscal policy is less effective than monetary policy in influencing output and

unemployment in the short run.

[5] None of the above.

15. According to the dynamic time inconsistency analysis of Kydland and Prescott, a monetary

policy rule:

[1] may tempt the central bank to deviate from announced policy commitments in the

future.

[2] is less likely than discretionary monetary policy to achieve the optimal combination of

inflation and unemployment over time.

[3] helps to lower the natural rate of unemployment.

[4] will ultimately lead to lower inflation and higher unemployment over time than would

be the case under discretionary monetary policy.

[5] All of the above.

16. According to the time inconsistency model of Barro and Gordon, discretionary monetary

policy is constrained by:

[1] the central bank's preference for lower unemployment now at the cost of higher

inflation and unemployment in the future.

[2] the trade-off between current output gains from cheating and the future costs thereof.

[3] the central bank's desire to maintain credibility.

[4] All of the above.

[5] None of the above.

17. The inflation targeting framework for monetary policy used by the South African Reserve

Bank (SARB) is an example of:

[1] discretionary policy.

[2] goal independence.

[3] a money supply growth rule.

[4] instrument independence.

[5] None of the above.

18. The empirical evidence over the long run suggests that greater central bank independence

is associated with:

[1] lower inflation and higher economic growth.

[2] lower inflation and lower economic growth.

[3] lower inflation.

[4] no significant difference in either inflation or economic growth.

[5] None of the above.

19. According to new classical economists, the best way to lower unemployment is to:

[1] increase aggregate demand by coordinating monetary and fiscal policies.

[2] lower the supply of labour.

[3] increase the flexibility of labour markets.

[4] increase the demand for labour.

[5] None of the above.

20. The Lucas critique of econometric models as a guide to policy argues that:

[1] because expectations change with changes in policy, econometric policy evaluation

is impossible.

[2] only unannounced or unsystematic changes in monetary policy have any real effects

on the economy.

[3] policy changes lead to changes in expectations and thus changes in the parameters

of the equations being estimated such that the forecasts of models that do not take

account of this are unreliable.

[4] because rational economic agents react unpredictably to unannounced policy

changes, the effects of such changes on the economy cannot be estimated

econometrically.

[5] uncertainty about policymakers intentions renders such econometric models

fundamentally flawed and wildly incorrect.

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21. Which of the following has proved to be the most problematic and contested feature of

new classical economics?

[1] The rational expectations hypothesis.

[2] Voluntary unemployment.

[3] The neutrality of money.

[4] Continuous optimising market clearing equilibrium.

[5] The policy ineffectiveness proposition.

22. The outcomes of the Reagan (USA) and Thatcher (UK) deflations in 1980-82 support

which of the following features of new classical economics?

[1] The policy ineffectiveness proposition.

[2] Monetary equilibrium business cycle theory.

[3] The neutrality of money.

[4] The signal extraction problem.

[5] None of the above.

23. The main contribution of new classical economics to the development of macroeconomics

appears to have been:

[1] the policy ineffectiveness proposition.

[2] the concept of the natural rate of unemployment.

[3] monetary equilibrium business cycle theory.

[4] rational expectations and dynamic time inconsistency policy analysis.

[5] the signal extraction problem.

24. Krugman (2000) [see E-Reserves] explains how the development of micro-foundations for

the aggregate supply function included:

a. the permanent income/life-cycle approach.

b. menu cost models.

c. the natural rate hypothesis.

d. the Lucas signal extraction confusion model.

[1] a b

[2] b c

[3] b d

[4] a b c

[5] b c d

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25. Krugman (2000) argues that macroeconomic models that are more fully specified with

regard to the rationality postulate and their micro-foundations:

[1] are more accurate than simpler ad hoc models such as the IS-LM model.

[2] are more realistic and thus a better guide to policy than cruder ad hoc models.

[3] are more rigorous theoretically and should thus replace simpler ad hoc models such

as the IS-LM model.

[4] have not succeeded because they are too complicated and thus contain logical

inconsistencies.

[5] None of the above.

26. A fundamental challenge faced by Keynesians during the 1970s was:

[1]the incorporation of expectations in their models.

[2] providing microeconomic explanations for non-market clearing.

[3] the incorporation of supply shocks in their model.

[4] the modification of the standard Phillips curve.

[5] None of the above.

27. Which of the following orthodox Keynesian propositions is/are supported by new

Keynesians?

[1] Stabilisation policies can be used to combat severe aggregate demand and supply

shocks.

[2] Fiscal policies can be used to permanently increase output and employment.

[3] Monetary policy can be used to permanently increase output and employment.

[4] All of the above.

[5] None of the above.

28. Which of the following propositions is/are compatible with new Keynesian economics?

[1] Continuous market clearing.

[2] The weak version of Say's Law.

[3] The strong version of Say's Law.

[4] Confusion by workers and firms of a change in the general price level with a change

in their own relative wage and product prices.

[5] Perfectly flexible prices and wages.

29. Which of the following is/are part of new Keynesian economics?

[1] Rational expectations.

[2] The natural rate of output and unemployment.

[3] Sticky prices and wages.

[4] Neutrality of money in the long run.

[5] All of the above.

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30. The main aim of the new Keynesian research effort was to:

[1] find empirical evidence to support price and wage rigidity.

[2] prove that money is non-neutral.

[3] show that demand and supply shocks have an impact on output.

[4] show that price and wage rigidity can be explained in terms of optimising behaviour.

[5] show that both monetary and fiscal policies can stabilise the economy.

Questions 31 to 42 are based on the following:

The Great Recession

The great recession originated in the financial markets of the United States of America in 2007.

It was triggered by falling house prices which led to the so-called "subprime mortgage" crisis.

Preceding the crisis there was a rapid increase in mortgages to less creditworthy borrowers. A

combination of falling house prices and default mortgage payments led to the failure and near

failure of major financial institutions in America. This sent shockwaves across the financial

markets of the world and resulted in a loss of confidence in financial markets and institutions,

with the result that share prices fell sharply, investor confidence plunged and the availability of

credit to firms and households was severely curtailed. This had the result that consumption

spending by households and investment spending by firms declined which had a major impact

on the level of output and unemployment.

Questions 31 to 40 refer to the diagram on page 397 of the textbook.

31.According to the new Keynesian theory of the business cycle, the above events led to:

[1] a rightward shift of the aggregate demand curve.

[2] a leftward shift of the aggregate demand curve.

[3] a leftward shift of the long-run aggregate supply curve.

[4] a rightward shift of the short-run aggregate supply curve.

[5] an increase in the natural rate of unemployment.

32. If prices and wages are fully flexible:

[1] the aggregate demand curve does not shift and the economy stays at point E0 in

diagram (a).

[2] the short run aggregate supply curve shifts downwards and the economy moves to

point E2 in diagram (a).

[3] the aggregate demand curve shifts to the left and the economy moves to point E1 in

diagram (a).

[4] the aggregate demand curve shifts to the left and the economy moves to point E2 in

diagram (a).

[5] the long run aggregate supply curve shifts to the left and the economy moves to point

E1 in diagram (a).

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33. Nominal price rigidity arises at point E1:

[1] due to the existence of menu costs.

[2] due to near-rational behaviour by firms.

[3] due to coordination problems between firms.

[4] because firms have some control over the price of their products.

[5] All of the above.

34. The reason firms move off their notional demand for labour curve is because:

[1] prices and real wages are fully flexible.

[2] prices and real wages are fixed in the long run.

[3] the effective demand for labour is higher than the notional demand for labour.

[4] the notional demand for labour is lower than the effective demand for labour.

[5] None of the above.

35. Involuntary unemployment increases:

[1] due to nominal wage rigidity at w0.

[2] since the lower real wage increases the supply of labour.

[3] since the decrease in output decreases the demand for labour.

[4] All of the above.

[5] None of the above.

36. Given the decline in consumer and investor confidence, a decline in the wage rate in the

labour market diagram (d):

[1] causes the quantity of labour supplied to decrease.

[2] leaves the employment of labour unchanged since the demand for labour is

constrained by the demand for goods.

[3] has no effect on the effective demand for labour.

[4] decreases the amount of involuntary unemployment.

[5] All of the above.

37. Given the decline in consumer and investor confidence, an increase in the wage rate in the

labour market diagram (d):

[1] leaves the employment of labour unchanged since the amount of labour available is

constrained by the supply of labour.

[2] causes firms to employ less labour since the cost of labour is higher.

[3] causes the quantity of labour supplied to increase.

[4] decreases the amount of involuntary unemployment.

[5] None of the above.

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38. According to the above model, the severity of the recession was intensified by:

[1] sticky prices and wages.

[2] the unwillingness of banks to lend money.

[3] the mispricing of risk.

[4] rational expectations.

[5] All of the above.

39. In the long run:

[1] price and wage flexibility ensure that the economy moves back to output level Y0.

[2] the fall in aggregate demand leads an increase in the price level and a decrease in

real wages.

[3] there is involuntary unemployment L0-L1.

[4] there is voluntary unemployment L0-L1.

[5] None of the above.

40. According to the above model, which of the following is an appropriate policy in the short

run to deal with the increase in involuntary unemployment during the Great Recession?

[1] Increased price competition between firms.

[2] Creation of a more flexible labour market.

[3] Nationalisation of key industries.

[4] Increasing the budget deficit and lowering interest rates.

[5] All of the above.

41. Skidelsky (2011) [see E-Reserves] emphasized the following factor(s) as contributing to

the severity of the Great Recession:

[1] the rigidity of prices and wages that impeded the adjustment of the economy.

[2] an increase in the marginal efficiency of investment due to a loss of confidence.

[3] mispricing of risky assets.

[4] decreased liquidity preference.

[5] None of the above.

42. The severity of a recession can be magnified by credit market imperfections in which:

[1] there is asymmetric information about creditors.

[2] financial institutions are risk averse.

[3] the cost of credit increases.

[4] credit rationing takes place.

[5] All of the above.

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43. In considering the effect of menu costs on the economy, Mankiw argues that:

[1] they represent a significant cost to the individual firm.

[2] they are an insignificant cost for the firm and therefore have very little effect on the

economy.

[3] menu costs help to explain real price rigidities.

[4] they may contribute significantly to the duration and severity of recessions.

[5]None of the above.

44. Regarding the natural rate of unemployment, Mankiw explains that:

[1] the concept of voluntary unemployment is more useful in practice.

[2] it can be influenced by monetary policy.

[3] it is disputed by some new Keynesians who emphasize the presence of hysteresis

effects.

[4] it is not influenced by labour market policies.

[5]the economy automatically moves to it in the short run.

45. Which of the following is/are not part of new Keynesian policies?

[1] A more flexible labour market where the power of labour is reduced.

[2] Flexible monetary and fiscal policy rules in order to anchor the economy.

[3] Monetary policy interventions to combat severe aggregate demand or supply shocks

to the economy.

[4] Smoothing out the upswings and downswings of the business cycle.

[5] Inflation targeting.

46. Which of the following can be regarded as a major contribution of new Keynesian

economics?

[1] Demonstrating the validity of rational expectations.

[2] Demonstrating the importance of effective demand.

[3] Providing empirical evidence for the existence of price and wage rigidities.

[4] Strengthening the forecasting accuracy of macroeconomic models.

[5] None of the above.

47. Both new classical economists and (some) new Keynesians make use of rational

expectations. The main difference between the two is:

[1] the way in which rational expectations are formed.

[2] that new classical economists combine it with perfectly flexible prices and wages

while new Keynesians combine it with sticky wages and prices.

[3] that new classical economists combine it with the neutrality of money while new

Keynesians combine it with the non-neutrality of money.

[4] All of the above.

[5] None of the above.

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48. New classical economists argue that anticipated and systematic changes in the money

supply will be reflected entirely in corresponding changes to the price level and inflation

without any effect on real variables. New Keynesians:

[1] fully agree with new classical economists in this regard.

[2] disagree since this may affect real variables in the short run.

[3] disagree since expectations are adaptive and not rational in the short run.

[4] disagree since this may affect nominal variables in the long run.

[5] disagree since the credibility of the monetary authority is an important issue not

considered by new classical economists.

49. New Keynesians regard the sacrifice ratio as positive:

[1] since there is a positive relationship between inflation and output in the long run.

[2] since prices and wages are flexible in the long run.

[3] since expansionary policies are required to bring down inflation.

[4] only when the monetary authority has established its credibility sufficiently to make its

policies effective.

[5] None of the above.

50. Which of the following is a new Keynesian explanation of the rise in unemployment in

South Africa following the financial crisis of 2007/2008?

[1] A sharp depreciation of the exchange rate.

[2] A sharp increase in the natural rate of unemployment.

[3] Sharply lower foreign demand for exports from South Africa.

[4] A supply shock which decreased the level of output and demand for labour.

[5] An increase in menu costs contributing to wage rigidity and excess supply of labour.