Page 383 - Krugmans Economics for AP Text Book_Neat

Bank of Japan—the equivalent of the Federal Reserve—repeatedly cut interest rates.
Eventually, it arrived at the “ZIRP”: the zero interest rate policy. The “call money rate,”
the equivalent of the U.S. federal funds rate, was literally set equal to zero. Because the
economy was still depressed, it would have been desirable to cut interest rates even fur-
ther. But that wasn’t possible: Japan was up against the zero bound.
In 2008 and 2009, the Federal Reserve also found itself up against the zero bound.
In the aftermath of the bursting of the housing bubble and the ensuing financial crisis,
the interest on short-term U.S. government debt had fallen to virtually zero.

Module 34 AP Review Section 6 Inflation, Unemployment, and Stabilization Policies
Solutions appear at the back of the book.

Check Your Understanding
1. Explain how the short - run Phillips curve illustrates the negative 3. Why is disinflation so costly for an economy? Are there ways
relationship between cyclical unemployment and the actual to reduce these costs?
inflation rate for a given level of the expected inflation rate.
4. Why won’t anyone lend money at a negative nominal rate of
2. Why is there no long - run trade - off between unemployment interest? How can this pose problems for monetary policy?
and inflation?

Tackle the Test: Multiple-Choice Questions
1. The long-run Phillips curve is c. the long-run Phillips curve upward.
I. the same as the short-run Phillips curve. d. the long-run Phillips curve downward.
II. vertical. e. neither the short-run nor the long-run Phillips curve.
III. the short-run Phillips curve plus expected inflation.
4. Bringing down inflation that has become embedded in
a. I only
expectations is called
b. II only
a. deflation.
c. III only
b. negative inflation.
d. I and II only
c. anti-inflation.
e. I, II, and III
d. unexpected inflation.
2. The short-run Phillips curve shows a relationship e. disinflation.
between .
5. Debt deflation is
a. negative the aggregate price level and aggregate output
a. the effect of deflation in decreasing aggregate demand.
b. positive the aggregate price level and aggregate output
b. an idea proposed by Irving Fisher.
c. negative unemployment and inflation
c. a contributing factor in causing the Great Depression.
d. positive unemployment and aggregate output
d. due to differences in how borrowers/lenders respond to
e. positive unemployment and the aggregate price level
inflation losses/gains.
3. An increase in expected inflation will shift e. all of the above.
a. the short-run Phillips curve downward.
b. the short-run Phillips curve upward.
Tackle the Test: Free-Response Questions
1. a. Draw a correctly labeled graph showing a short-run Phillips c. On your graph, show what happens in the long run if the
curve with an expected inflation rate of 0% and the government decides to decrease the unemployment rate
corresponding long-run Phillips curve. below the nonaccelerating inflation rate of unemployment.
b. On your graph, label the nonaccelerating inflation rate of Explain.
unemployment.

module 34 Inflation and Unemployment: The Phillips Curve 341