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Advocates of the active approach believe that discretionary government policy can restore economic stability and improve economic performance.


To favor a passive approach to policy is to believe that the private sector is

relatively stable and both wages and prices adjust quickly to eliminate excess supply or excess demand for labor

According to those who favor a passive approach to policy, how will the economy shown in Exhibit 16-1 attain equilibrium at potential output?

The SRAS curve will shift to the right.

If an active approach to policy is followed, how would an expansionary gap eventually close?

The aggregate demand curve would shift leftward.

Problems facing active policy decisions include

Both 3) and 4)

The time it takes to identify and examine the nature and seriousness of an economic problem is the

recognition lag

One reason that long time lags hamper the effectiveness of economic policy is that

by the time the impact of a policy is felt, a new problem may have come along that requires a different policy, which may make the economic situation even worse

An effective policy of governmental intervention in the economy requires all of the following except one. Which is the exception?

the will to reject sound policy if it gets in the way of political considerations

According to the rational expectations school, people base their expectations about inflation on

all information available to them

Economists of the rational expectations school believe that expansionary monetary policy is fully effective only if

the policy is totally unexpected

According to the rational expectations school, if the Fed announces a policy of rapid growth in the money supply, but then puts the brakes on money expansion without any announcement, the short-run result is likely to be

an unexpected drop in aggregate demand

The time inconsistency problem occurs when

all of the following occur

The main policy conclusion of the rational expectations school is

neither monetary nor fiscal policy can be helpful if firms and households correctly anticipate the plans of policy makers

In the early 1960s, the discovery of the Phillips curve relationship caused economists and policy makers to think that they understood the tradeoffs between

inflation and unemployment

On the Phillips curve graph, the immediate effects of a discretionary increase in government spending are represented by a

movement along the Phillips curve

The short-run Phillips curve is drawn for a given expected inflation rate and so it shifts as inflation expectations change.


The long-run Phillips curve is located at the natural rate of unemployment.


Consider Exhibit 16-4. If the economy is initially at point c and aggregate demand increases, the economy will (in the long run)

move toward point a

All of the following are true along a long-run Phillips curve except one. Which is the exception?

inflation and unemployment are inversely related

According to the natural rate hypothesis, the natural rate of unemployment is

largely independent of the level of aggregate demand stimulus provided by fiscal or monetary policy

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