Exam 28: Inflation, Unemployment, and Federal Reserve Policy

Article Summary Since the Fed introduced its annual goal of an inflation target of 2 percent in January 2012, the personal consumption expenditures price index has fallen short of this goal more than 90 percent of the time. This has prompted some analysts and Fed officials to acknowledge that the Fed has lost some of its credibility in achieving its 2 percent target, and has Fed officials again discussing whether to hold off on raising interest rates. Fed Governor Lael Brainard stated that the Fed's failure to increase inflation to its 2 percent target may have influenced how companies and consumers view the inflation outlook, stating "Households and firms have experienced a prolonged period of inflation below our objective, and that may be affecting their perception of underlying inflation." Since expectations influence the actions of companies and consumers, they help determine where inflation actually ends up. Consumers who are accustomed to low inflation will resist paying up for goods and services, and therefore companies will avoid increasing wages, fearing they won't be able to raise prices to cover the added labor costs. It's a vicious circle that can hinder the Fed from achieving its inflation target. -Refer to the Article Summary. Some analysts and Fed officials have acknowledged that the Fed has lost some of its credibility in achieving its 2 percent inflation goal, since inflation has fallen short of this goal over 90 percent of the time since it was announced in January 2012. Prior to this, over the past 25 years whenever a change in Fed policy had been announced, the change has ________ taken place, leading to ________ credibility.

Two actions by the Fed during Alan Greenspan's term as chairman have been identified as possibly contributing to the financial crisis in 2008. Which of the following was one of those actions?

Which of the following is an appropriate policy for a central bank to follow if the economy is plagued with deflation?

Explain why an anticipated expansionary monetary policy would not result in reduced unemployment rates if workers and firms have rational expectations.

During the 1960s, when confronted with moderate and stable inflation, people tended to form adaptive expectations of future inflation rates.

With which of the following statements would a "real business cycle" theorist most closely agree?

If the unemployment rate in the economy is steady at 4 percent per year, how does the short-run Phillips curve predict that the inflation rate will be changing, if at all? What will happen if the unemployment rate now rises to 7 percent per year? Assume there are no changes to inflation expectations. Provide an appropriate graph to support your discussion.

Even if expectations of inflation are rational, sluggish adjustment of wages and prices will still create a short-run trade-off between inflation and unemployment.

Does the short-run Phillips curve have a positive or negative slope? Explain how this slope is derived.

In the short run, the Federal Reserve can affect which of the following?

Last year, the unemployment rate was 4 percent and the inflation rate was 3 percent. If the natural rate of unemployment is 3 percent, how do you expect inflation to change?

In conducting monetary policy, how has the Federal Reserve enhanced its credibility?

If workers and firms lower their inflation expectations

An increase in frictional unemployment will

Figure 28-7 -Refer to Figure 28-7. Consider the Phillips curves depicted in the graph above. The Fed announces its intention to decrease inflation from 10 percent to 5 percent per year, and it succeeds. If expectations of inflation are not altered by the Fed's announcement, the rate of unemployment will be ________ in the short run.

Figure 28-4 -Refer to Figure 28-4. Consider the shift in the short-run Phillips curves shown in the above graph. This shift may be explained by

If wages and prices adjust slowly, we would expect expansionary monetary policy to be

According to ________, the economy is normally at potential GDP.

When individuals use ________ about an economic variable to make a decision, expectations are rational.

Which of the following would decrease the natural rate of unemployment?