Page 356 - Krugmans Economics for AP Text Book_Neat

Tackle the Test: Multiple-Choice Questions
1. At each meeting of the Federal Open Market Committee, the 4. Which of the following is a goal of monetary policy?
Federal Reserve sets a target for which of the following? a. zero inflation
I. the federal funds rate b. deflation
II. the prime interest rate c. price stability
III. the market interest rate d. increased potential output
a. I only e. decreased actual real GDP
b. II only
5. When implementing monetary policy, the Federal Reserve
c. III only
attempts to achieve
d. I and III only
a. an explicit target inflation rate.
e. I, II, and III
b. zero inflation.
2. Which of the following actions can the Fed take to decrease the c. a low rate of deflation.
equilibrium interest rate? d. a low, but positive inflation rate.
a. increase the money supply e. 4–5% inflation.
b. increase money demand
c. decrease the money supply
d. decrease money demand
e. both (a) and (d)
3. Contractionary monetary policy attempts to
aggregate demand by interest rates.
a. decrease increasing
b. increase decreasing
c. decrease decreasing
d. increase increasing
e. increase maintaining

Tackle the Test: Free-Response Questions
1. a. Give the equation for the Taylor rule. 2. a. What can the Fed do with each of its tools to implement
b. How well does the Taylor rule fit the Fed’s actual behavior? expansionary monetary policy during a recession?
Explain. b. Use a correctly labeled graph of the money market to explain
c. What does the Taylor rule predict will happen when the how the Fed’s use of expansionary monetary policy affects
inflation rate increases? Explain. interest rates in the short run.
d. What does the Taylor rule predict will happen if the c. Explain how the interest rate changes you graphed in part b
economy sinks further into a recession? Explain. affect aggregate supply and demand in the short run.
d. Use a correctly labeled aggregate demand and supply graph
to illustrate how expansionary monetary policy affects
Answer (7 points)
aggregate output in the short run.
1 point: Federal funds rate = 1 + (1.5 × inflation rate) + (0.5 × output gap)
1 point: Not exactly, but fairly well

1 point: It does better than any one measure alone, and it has always correctly
predicted the direction of change of interest rates.
1 point: The federal funds rate will increase.
1 point: According to the equation, the federal funds rate increases by 1.5
percentage points for every one percentage point increase in inflation. OR, the
Taylor rule predicts contractionary monetary policy during periods of inflation.
1 point: The federal funds rate will decrease.
1 point: According to the equation, the federal funds rate decreases by 0.5
percentage points for every one percentage point decrease in the output gap, as
from −1% to −2%, indicating a deeper recession. OR, the Taylor rule predicts
expansionary monetary policy during periods of recession.

314 section 6 Inflation, Unemployment, and Stabilization Policies