This whole quiz seemed to do an unusually good job of dividing those who know whats going on from those who don't -- every question had a huge gap on percent correct between those in the top half overall and those not. If you got C or less, study this!  The percentages right refer to a large class in 1996.

Suppose in the US unemployment was 4% but the inflation rate was 12% per annum. Suppose a changed macropolicy was put in place with the intention of reducing inflation. Then [questions 1 through 6]

1. Nominal interest rates would be likely to :

a. increase b. decrease c. remain unchanged d. increase at first, but then fall as inflation falls

OK, this is a hard question to start with, but important. Monetary policy is going to be tightened, so nominal interest rates will rise initially; but the objective is to slow inflation, and nominal interest rates are "real + inflation;" although real interest rates may rise a little at first, the fall in inflation will more than offset that so nominal interest rates fall as inflation falls. Only 26% got it.

2. The Federal Reserve would likely be :

a. buying bonds from the public b. selling bonds to the public c. buying bonds from the Government d. selling bonds to the Government

We need a restrictionary monetary policy, i.e. reduce money supply, so the Fed has to sell bonds so that commercial bank reserves and the money supply falls. The Fed is not allowed to sell or buy bonds directly to the government. 46% got this one.

3. The prices of bonds in the bond market would likely be :

a. falling b. staying steady c. rising d. falling at first, then increasing as inflation falls

This is the reflection of questions 1. Price of long-term securities, i.e. bonds, move oppositely to nominal interest rates; as they rise, price of bonds falls (the Fed is selling them, increasing supply); then as nominal intersest rates fall when inflation slows, the price of bonds starts up again. 32% right.

4. If expectations are adaptive, the unemployment rate would :

a. not change b. increase, and remain above the natural rate until inflation stopped slowing c. immediately shift to the natural rate d. fall

OK, easier. This is almost the definition of adaptive expectations -- because they have to adapt, unemployment will be above the natural rate until inflation stops slowing. 65% got this.

5. If expectations were rational, compared to if they were adaptive, the unemployment rate would :

a. also not change b. increase faster and for longer c. increase, but only to the natural rate

d. increase, but how far and for how long would depend on how credible the new policy was

Even better. 70% got this; rational expectations imply expectations [and the economy] move immediately to the end-result with respect to inflation, IF the policy is 'credible;' if people have doubts, then the shift is slower.

6. Such a macropolicy would be called

a. expansionary b. restrictive c. non-activist d. non-discretionary

This is basically a definition; it is expansionary if you are trying to reduce unemployment [expand the money supply], restrictive if you are trying to reduce inflation [restrict the money supply]. This is also activist (you are doing something, not following a mechanical rule] and discretionary [somebody makes a discretionary decision, not following a mechanical rule]. Only 60% right, which surprised me.

7. Compared to the "non-activists," "activists" on macropolicy believe, among other things,

a. non-discretionary rules would make it difficult or impossible to respond to unexpected macro shocks, like changes in the velocity of money or the price of oil;

b. it is impossible to forecast the future well enough to improve macro performance by discretionary policy;

c. rules are needed to prevent manipulation of the economy for political reasons;

d. time lags before policy changes are felt in the economy are so changeable and uncertain that discretionary policy is more likely to make things worse than better.

Wording is long and awkward, but I would have hoped for better. b, c, and d are all reasons given for being "non-activist;" a is a reason for being activist. Only 39% right.

8. If people expect the inflation rate to increase, the short run Phillips Curve will

a. shift up (to the right) b. not change c. shift down (to the left) d. become vertical

Almost a definition, and 73% of you recognised it.

9. "Rational expectations" assumes

a. people take all relevant information into account in forming their expectations b. expectations are always correct c. forecast errors are random, not systematic d. a. and c.

You're learning to read all the responses, good: a is the definition, c is a consequence, and 81% of you got it.

10. "Adaptive expectations" assumes

a. people base their expectations on the recent past b. expectations are always wrong c. forecast errors can be sytematic, not random d. a. and c.

The symmetric question, the symmetric answer; but only 73% on this one -- more liked a, and a few took c, compared to question 9.