1. In a steady-state equilibrium with a constant positive rate of money growth and no output growth, the nominal interest rate will be constant and positive.
True. In a steady state, the real interest rate is constant. Since expected inflation equals the constant rate of money growth, the nominal interest rate (R = r + \(\pi^e\)) will also be constant and positive.
Source: McCallum (1989), Chapter 6.
2. The classical model assumes that involuntary unemployment is a persistent problem.
False. A core assumption of the classical model is perfect wage and price flexibility, which ensures the labor market always clears. Anyone who is not working has voluntarily chosen not to work at the prevailing real wage. Involuntary unemployment is zero.
Source: EC3115 Subject Guide, Chapter 8.
3. The Lucas misperceptions model provides a rationale for a short-run upward-sloping aggregate supply curve, but a vertical long-run aggregate supply curve.
True. In the short run, producers can misperceive a general price increase as a relative price increase, leading them to supply more output. In the long run, expectations adjust to reality, the misperception is corrected, and output returns to its natural rate, making the long-run supply curve vertical.
4. According to the Friedman rule, the optimal rate of money growth is always zero.
False. The Friedman rule advocates for a rate of money growth that leads to a rate of deflation equal to the real interest rate. This policy drives the nominal interest rate to zero, eliminating the opportunity cost of holding money.
Source: McCallum (1989), Chapter 6.
5. In the time inconsistency game between the government and the private sector, the Nash equilibrium is typically Pareto-inferior to the optimal, but non-credible, outcome.
True. The Nash equilibrium results in a positive inflation rate, which is suboptimal for both the government and the public compared to a zero-inflation outcome. However, the zero-inflation outcome is not a credible equilibrium because the government has an incentive to cheat.
6. Real Business Cycle models, like that of Long and Plosser, rely on monetary shocks as the primary impulse for fluctuations.
False. RBC models deliberately exclude monetary factors to demonstrate that real shocks (e.g., to technology or preferences) are sufficient to generate business cycle-like fluctuations in a competitive equilibrium framework.
Source: Long and Plosser (1983).
7. The real cost of an anticipated inflation includes the resources used to manage cash balances more intensively (e.g., more trips to the bank).
True. These are known as "shoe-leather costs." Because inflation is a tax on holding money, people try to hold less of it, which means they must engage in more frequent transactions to manage their liquidity, consuming real resources in the process.
Source: McCallum (1989), Chapter 6.
8. A key finding in Kydland and Prescott (1990) is that the money stock (M1) is strongly countercyclical.
False. Kydland and Prescott find that monetary aggregates like M1 and the monetary base are generally procyclical, moving with real GNP. They argue that the common belief that money *leads* the cycle is a myth.
Source: Kydland and Prescott (1990).
9. In a model with limited participation in financial markets, an open market purchase of bonds by the central bank can temporarily lower the nominal interest rate.
True. This is known as the liquidity effect. The new money is injected into the financial system, increasing the supply of loanable funds. Since only a subset of agents (the "limited participants") can adjust their portfolios immediately, the price of bonds rises and the interest rate falls to clear the market.
10. Hyperinflation ends only when the government credibly commits to a zero money growth rule.
False. While stopping the explosive money growth is essential, the key is a credible *fiscal* reform that eliminates the government's need to rely on seigniorage. Once the government can finance its spending through taxes or borrowing, the commitment to stop printing money becomes credible and the hyperinflation can end abruptly.
Source: McCallum (1989), Chapter 7.
11. The distinction between real and nominal interest rates is irrelevant if the price level is expected to be constant.
True. If expected inflation (\(\pi^e\)) is zero, the Fisher equation \(r = R - \pi^e\) simplifies to \(r = R\). In this case, the real and nominal rates are identical.
Source: McCallum (1989), Chapter 6.
12. If money is neutral, then it is also superneutral.
False. Superneutrality is a stronger condition than neutrality. A model can exhibit neutrality (level changes in M have no real effects) but fail to exhibit superneutrality (growth rate changes in M do have real effects), for example, through a real balance effect.
Source: McCallum (1989), Chapter 6.
13. One argument for using seigniorage is that it is a tax that is difficult to evade.
True. The inflation tax is imposed on all holders of the domestic currency. Unlike income or sales taxes, which can be evaded through black markets or non-reporting, the inflation tax is automatically levied on anyone holding money.
Source: General macroeconomic principles.
14. In the Lucas misperceptions model, a fully anticipated increase in the money supply will cause a temporary boom in output.
False. The real effects in the Lucas model are driven entirely by *unanticipated* policy, which creates a price surprise. If the increase is fully anticipated, agents will adjust their expectations, and the policy will be neutral, affecting only the price level.
Source: EC3115 Subject Guide, Chapter 8.
15. The welfare cost of a steady, anticipated inflation is finite, whereas the cost of hyperinflation can be catastrophic for an economy.
True. The welfare cost of moderate, anticipated inflation is typically measured as a small percentage of GNP (shoe-leather and menu costs). Hyperinflation, however, leads to a breakdown of the payments system, a collapse in investment and trade, and massive resource misallocation, representing a far greater social cost.
Source: McCallum (1989), Chapters 6 & 7.
16. The Fisher equation is an accounting identity that must hold true by definition at all times.
False. The Fisher equation is a behavioral theory or equilibrium condition, not an identity. It states that in equilibrium, the nominal interest rate will adjust to reflect the real rate and expected inflation. The *ex-post* version (using actual inflation) is an identity, but the theoretically important *ex-ante* version is not.
Source: McCallum (1989), Chapter 6.
17. In the basic classical model, the level of real output is determined by supply-side factors, and the price level is determined by the money supply.
True. This is the essence of the classical dichotomy. The vertical aggregate supply curve means output is determined by the labor market and the production function. Given this real output level, the quantity theory of money (or the LM curve) then determines the price level for a given money supply.
Source: EC3115 Subject Guide, Chapter 8.
18. The optimal inflation tax rate is the rate that maximizes the government's seigniorage revenue.
False. From a public finance perspective, the optimal inflation tax rate is the one that equates the marginal cost of raising revenue via inflation with the marginal cost of raising it via other distortionary taxes. This is generally well below the rate that would maximize seigniorage revenue.
Source: McCallum (1989), Chapter 6.
19. In the RBC model of Long and Plosser (1983), an unexpected increase in the output of one commodity leads to increased investment in the production of other commodities.
True. Because commodities are used as inputs into the production of other commodities, an unexpected abundance of one good makes it optimal to increase its use as an input across various production processes, spreading the shock across sectors.
Source: Long and Plosser (1983).
20. During the German hyperinflation of the 1920s, the growth rate of the money supply was consistently lower than the rate of inflation.
False. While the flight from currency meant that real money balances fell (i.e., prices rose faster than the money supply *at times*), the underlying driver was the massive expansion of the nominal money supply. On average over the whole period, money growth was the fundamental cause of the inflation.
Source: McCallum (1989), Chapter 7.
21. If the real interest rate is negative, a lender pays a borrower in real terms for the privilege of lending to them.
True. A negative real interest rate means that the principal and interest repaid will have less purchasing power than the original principal of the loan. The lender receives back fewer goods and services than they initially lent.
Source: General macroeconomic principles.
22. If money is neutral, then monetary policy is completely irrelevant.
False. Even if money is neutral with respect to real variables, monetary policy is still highly relevant as the primary determinant of the price level and the rate of inflation. Controlling inflation is a key objective of central banks.
Source: EC3115 Subject Guide, Chapter 8.
23. The welfare cost of anticipated inflation is represented by a triangle in the money demand diagram, reflecting the lost surplus from holding less money.
True. This area (the Bailey triangle) measures the total utility lost because the opportunity cost of holding money (the nominal interest rate) is above zero. It is the integral of the money demand curve from the level of real balances held under inflation to the level that would be held at a zero nominal interest rate.
Source: McCallum (1989), Chapter 6.
24. The time inconsistency problem implies that the best monetary policy is always discretionary, allowing for flexibility.
False. The time inconsistency problem suggests that pure discretion leads to a suboptimal outcome with an inflationary bias. The analysis suggests that pre-commitment to a policy rule, which removes discretion, can lead to a superior (lower inflation) outcome.
Source: Hargreaves Heap (1992), Chapter 4.
25. In the RBC framework, a shock that increases the productivity of capital will lead to a rise in investment.
True. An increase in the productivity of capital raises the real return on investment. Rational agents will respond to this higher return by increasing their investment to build up the capital stock, smoothing the benefits of the shock into the future.
Source: Plosser (1989).
26. The real wage is defined as the nominal wage divided by the nominal interest rate.
False. The real wage is the nominal wage (W) divided by the price level (P). It measures the purchasing power of the wage in terms of goods and services.
Source: Basic macroeconomic principles.
27. A government's ability to earn seigniorage is limited by the public's willingness to hold real money balances.
True. Seigniorage revenue is the product of the money growth rate and the level of real money balances. If money growth and inflation become too high, the demand for real money balances will fall, which limits and can even reduce the amount of real revenue the government can collect.
Source: EC3115 Subject Guide, Chapter 8.
28. According to the classical model, a 10% increase in the money supply leads to a 10% increase in the real interest rate.
False. In the classical model, money is neutral. A 10% increase in the money supply leads to a 10% increase in the price level and other nominal variables, but has no effect on real variables like the real interest rate.
Source: EC3115 Subject Guide, Chapter 8.
29. The analysis of hyperinflation by Cagan (1956) showed that money demand was surprisingly stable and predictable, even under extreme conditions.
True. A key finding of Cagan's study was that despite the chaotic economic environment, the demand for real money balances could be explained in a stable way by a simple function of expected inflation. This provided strong evidence for the stability of the money demand function.
Source: McCallum (1989), Chapter 7.
30. If money is superneutral, the nominal interest rate is invariant to the rate of money growth.
False. If money is superneutral, the real interest rate is invariant to the rate of money growth. A higher rate of money growth leads to a higher rate of inflation, which, via the Fisher effect, leads to a higher *nominal* interest rate.
Source: McCallum (1989), Chapter 6.
31. The Lucas critique implies that policy evaluation should be based on "deep" structural parameters (from preferences and technology) rather than on historical correlations.
True. The critique argues that since historical correlations in macroeconomic data reflect past policy rules, they are not reliable for predicting the effects of new policy rules. A proper policy evaluation requires a model based on the invariant parameters of agent preferences and technology.
Source: Hargreaves Heap (1992), Chapter 4.
32. The welfare cost of inflation is primarily due to the fact that it makes exports less competitive.
False. While inflation can affect the exchange rate and competitiveness, the core welfare cost of *anticipated* inflation in these models relates to the distortion of money-holding decisions, leading to shoe-leather and menu costs. The effect on exports is a separate, open-economy issue.
Source: McCallum (1989), Chapter 6.
33. In a Real Business Cycle model, the equilibrium quantities of consumption and investment fluctuate in response to productivity shocks.
True. The fluctuations are the result of optimal decisions by households. In response to a productivity shock, agents adjust their consumption, work effort, and investment over time to smooth consumption and take advantage of changes in the return to investment and work.
Source: Plosser (1989).
34. A government can collect unlimited real revenue through seigniorage simply by printing money at an ever-increasing rate.
False. This is contradicted by the inflation-tax Laffer curve. As inflation rises, the tax base (real money balances) shrinks. Beyond a certain point, the shrinking of the base is so severe that total real revenue falls, even as the inflation rate continues to increase.
Source: EC3115 Subject Guide, Chapter 8.
35. The Fisher equation suggests that if the real interest rate is stable, changes in expected inflation will be fully reflected in changes in the nominal interest rate.
True. If \(r\) is constant, then \(\Delta R = \Delta \pi^e\). This one-for-one relationship is the essence of the Fisher effect.
Source: McCallum (1989), Chapter 6.
36. In the classical model, monetary policy is a powerful tool for stabilizing short-run fluctuations in employment.
False. In the classical model, money is neutral. Monetary policy only affects nominal variables. Employment is a real variable determined in the labor market and is always at its full-employment level, unaffected by monetary policy.
Source: EC3115 Subject Guide, Chapter 8.
37. The existence of a time inconsistency problem in monetary policy provides a rationale for policy rules over discretion.
True. The time inconsistency problem shows that discretionary policy can lead to a suboptimal inflationary bias. A binding rule can remove the discretion to create surprise inflation, allowing the economy to achieve a more efficient, low-inflation equilibrium.
Source: Hargreaves Heap (1992), Chapter 4.
38. According to Kydland and Prescott, investment is less volatile than consumption over the business cycle.
False. A key business cycle fact they highlight is that investment expenditures are significantly *more* volatile than consumption expenditures. Consumption (especially of non-durables and services) tends to be much smoother than output, while investment is much more volatile.
Source: Kydland and Prescott (1990).
39. A key assumption in the Cagan model is that the demand for real money balances is a negative function of the expected rate of inflation.
True. This is the central behavioral relationship in the model. Expected inflation is the opportunity cost of holding money, so as it rises, the quantity of real balances demanded falls.
Source: McCallum (1989), Chapter 7.
40. If money is neutral, a change in the money supply has no effect on the nominal wage rate.
False. Neutrality means a change in the money supply affects *all* nominal variables proportionally, but has no effect on *real* variables. The nominal wage rate will rise in proportion to the money supply and the price level, leaving the real wage unchanged.
Source: EC3115 Subject Guide, Chapter 8.
41. The real interest rate can be interpreted as the marginal product of capital in a neoclassical growth model.
True. In equilibrium, firms will invest up to the point where the marginal product of capital (the real return from an additional unit of capital) equals the real interest rate (the real cost of borrowing to finance that investment).
Source: Plosser (1989).
42. The Lucas misperceptions model assumes that agents have perfect information about the aggregate price level but imperfect information about the price of their own good.
False. It is the other way around. Agents are assumed to know the price of their own good perfectly but have imperfect information about the aggregate price level, leading them to potentially confuse a general price increase with a relative price increase.
Source: EC3115 Subject Guide, Chapter 8.
43. The theory of optimal taxation suggests that if a government must rely on distortionary taxes, it should not necessarily set the inflation tax to zero.
True. The theory suggests that the marginal welfare cost of the last dollar raised should be equal across all tax instruments. If the marginal cost of raising revenue from other taxes (like income tax) is positive, then it is optimal to use the inflation tax up to the point where its marginal cost is equal to that of the other taxes.
Source: McCallum (1989), Chapter 6.
44. In the RBC model of Long and Plosser (1983), labor input is highly volatile because of large, exogenous shocks to labor supply.
False. In their model, labor input is constant. This is a known limitation of that specific formulation. Later RBC models introduced features like non-separable utility to generate more realistic volatility in labor input.
Source: Long and Plosser (1983).
45. A higher expected inflation rate, for a given nominal interest rate, implies a lower real interest rate.
True. This follows directly from the Fisher equation, \(r = R - \pi^e\). If \(R\) is fixed, an increase in \(\pi^e\) must lead to a decrease in \(r\).
Source: McCallum (1989), Chapter 6.
46. The term "classical dichotomy" implies that money growth has no effect on inflation.
False. The classical dichotomy implies that money affects *only* nominal variables. Inflation is a nominal variable (the rate of change of the price level), and it is directly determined by the rate of money growth in the classical model.
Source: EC3115 Subject Guide, Chapter 8.
47. Menu costs, which are the physical costs of changing prices, can help explain why firms might not adjust prices immediately in response to a shock, contributing to short-run monetary non-neutrality.
True. Menu costs are a central concept in New Keynesian economics. Even small costs of changing prices can make it optimal for firms to keep prices fixed after a shock, leading to quantities adjusting instead. This price stickiness allows monetary policy to have real effects in the short run.
Source: Hargreaves Heap (1992), Chapter 6.
48. The primary way to stop a hyperinflation is for the central bank to implement a system of wage and price controls.
False. Wage and price controls may be used as a temporary measure, but they do not address the fundamental cause. A hyperinflation can only be stopped by a credible fiscal reform that eliminates the government's need to print money to finance its deficit.
Source: McCallum (1989), Chapter 7.
49. In the RBC framework, business cycles are not seen as deviations from an optimal path but rather as the optimal path itself, given the shocks that have occurred.
True. Because the fluctuations are the result of rational, maximizing agents responding optimally to real shocks in a competitive environment, the resulting business cycle is Pareto optimal. There is no market failure to correct.
Source: Plosser (1989).
50. If the real interest rate is 5% and the expected inflation rate is -2% (deflation), the nominal interest rate is 7%.
False. Using the Fisher equation \(R = r + \pi^e\), the nominal interest rate is \(5\% + (-2\%) = 3\%\).