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Question 1

The above figure represents a short-run equilibrium of a small economy in a fixed exchange rate regime.
The reason that the long-run aggregate demand curve is horizontal at the rate of inflation of the rest of the world π* is...

a) ...in the long-run the price level is assumed perfectly flexible.

b) ...under fixed exchange rates, the money supply is exogenous.

c) ...the marginal propensity to import is assumed to be a constant fraction of GDP.

d) ...the principle of long-run PPP.

Question 2

The AD curve is downward sloping for a small economy in a fixed exchange rate system because (A) __________ weakens the country's external competitiveness, which (B) ____________ for domestic goods.

a) (A) positive domestic inflation; (B) reduces domestic and foreign demand

b) (A) positive domestic inflation; (B) increases the domestic demand

c) (A) rising domestic inflation; (B) reduces domestic and foreign demand

d) (A) rising domestic inflation; (B) increases the domestic demand

Question 3

For a small economy in a fixed exchange rate system in the long run, the domestic underlying rate of inflation must equal the foreign rate of inflation because:

a) Otherwise the real exchange rate would change.

b) The Principle of Purchasing Power Parity would be violated.

c) This is inconsistent with Okun's Law.

d) Each must equal the domestic rate of inflation so that AS does not shift and the relative competitiveness of domestic goods does not change.

Question 4

For a small economy in a fixed exchange rate system that begins in period 0 at the long-run equilibrium point A, the government cuts net taxes moving the aggregate demand curve from its initial position AD to AD´ so that the economy is in short-run equilibrium in period 1 at point B. Assume the backward looking component of core-inflation dominates the forward looking component.
Which of the following observations will not be true of the ultimate long-run that this economy will attain after the policy change of period 1?

a) All non-zero output gaps imply core and actual inflation differ.

b) The fiscal expansionary policy must eventually be reversed for fiscal sustainability.

c) The domestic rate of inflation cannot deviate from the foreign rate of inflation.

d) The new long-run equilibrium will have higher inflation and higher unemployment (i.e. stagflation).

Question 5

For a small economy in a flexible exchange rate system that begins in long-run equilibrium point, a higher rate of inflation in the short run will be followed by:
The central bank responding with (A)________ which will result in a (B)______________.

a) (A) an increase in the exchange rate ; (B) decline in net exports.

b) (A) a decrease in the exchange rate ; (B) an increase in net exports.

c) (A) contractionary monetary policy ; (B) real exchange rate appreciation.

d) (A) expansionary monetary policy ;(B) real exchange rate depreciation.

Question 6

Consider a small economy in a flexible exchange rate system that begins in long-run equilibrium at point A.
After a permanent increase in the central bank's inflation target, the line TR goes down because an increase in the permanent inflation target of the central bank is (A) _____________ monetary policy. The IFM line shifts up because the higher rate of inflation implies (B)___________ of the exchange rate.

a) (A) a contractionary ; (B) depreciation

b) (A) a contractionary ; (B) appreciation

c) (A) an expansionary; (B) depreciation

d) (A) an expansionary; (B) appreciation

Question 7

In the period that it occurs, an adverse supply shock simultaneously (A)____________ and increases (B) ______________.

a) (A) changes the Taylor rule; (B) actual inflation

b) (A) changes the Taylor rule; (B) underlying inflation

c) (A) lowers output ; (B) actual inflation

d) (A) lowers output; (B) underlying inflation

Oxford University Press, Online Resource Centre, Chapter 13.

Chapter 13