Econ Adventure # 3
Incurring a federal budget deficit will increase the size of the public debt
TRUE
One significant characteristic of fractional reserve banking is that banks are vulnerable to panics or runs.
TRUE
One significant characteristic of fractional reserve banking is that banks create money through lending their reserves
TRUE
When a commercial bank makes a loan it monetizes the credit extended to a borrower
TRUE
State and local government fiscal policies _______ federal fiscal policy
offsetting State fiscal policy is pro-cyclical and annually balance their budgets
Financing war time expenditures by increasing internally-held public debt permits a nation to defer a part of the economic cost of war
FALSE
Fiscal policy refers to changing the level of government spending and taxes to achieve a greater equality in the distribution of income.
FALSE
Money must be created through the banking system
FALSE
Non-discretionary fiscal policy refers to Congress changing the tax and transfer payments system during a recession or inflationary boom to stabilize the size of government.
FALSE
One function of money is to serve as an encouragement to work
FALSE
One function of the Federal Reserve is to issue new government securities to finance a federal budget deficit
FALSE
Tax rates are an example of an automatic stabilizer
FALSE
The backing for the money in the United States comes from the confidence the public has in the ability of the President.
FALSE
The crowding-out effect suggests that increases in consumption are usually at the expense of saving.
FALSE
The gold stored at Fort Knox backs the paper money in the United States.
FALSE
The primary objective of fiscal policy is to stabilize the size of the federal debt
FALSE
The public debt is the accumulation of household, business, and government debt over time
FALSE
To keep inflation from eroding the value of money, policymakers in the United States establish insurance (FDIC) on checkable deposit accounts.
FALSE
To keep inflation from eroding the value of money, policymakers in the United States make paper money legal tender.
FALSE
To say money is socially defined means that society, acting through Congress, specifies what shall be money
FALSE
Your personal check drawn on a commercial bank is legal tender.
FALSE
A $10 billion increase in G is more expansionary than a $10 billion decrease in Tx because a portion of the tax cut will be saved
TRUE
During periods of hyperinflation, a nation's money may cease to function as a medium of exchange because people will not want to accept it in transactions.
TRUE
Paper money in the United States is a debt or liability of the Federal Reserve Banks
TRUE
Tax revenues are an example of an automatic stabilizer
TRUE
The backing for the money in the United States depends on its acceptability as a medium of exchange.
TRUE
Required to balance the budget (Economic boom)
Tax revenues must decrease and/ or government spending must decrease, this will worsen the inflation
Required to balance the budget (Recession)
Tax revenues must increase and/or government spending must decrease, this will worsen the recession
Consumption smoothing
Temporary change in taxes: spend a little save in case of an inc in prices Permanent change in taxes: spend a lot and not saving as much
When money serves as a means for determining the relative worth of an item money functions as a
Unit of account
Intrinsic value
Use or value in and of itself (eat a cow, spend the silver)
Net tax revenues
Vary directly with GDP
If C decreases then real GDP
decreases
If disposable income decreases by x, then consumer spending (C and S)
decreases
If taxes increase by x, then disposable income
decreases by x
Barter
exchanging of one good for another good (socially accepted) Trade requires a double coincidence of want, no common measure of value, and opportunity cost is high
Primary function of reserves
give the Fed influence over the lending ability of commercial banks by manipulating the reserve ratio or level of required reserves
A commercial bank temporarily short of required reserves may replenish reserves by
borrowing reserves in the federal funds market.
Easy money
pushes a recession into an expansion
Tight money
pushes an expansion into a contraction
Bank liabilities
sources of funds
Automatic stabilizers
"built in" to fed govt programs so the dollar amounts change do not suffer from timing problems: no recognition lag/ no administration lag
In a 100% reserve banking system the reserve ratio is ___% and the money multiplier is _____
100% ; 1
Check clearing
Bank against which a check is drawn and cleared loses both reserves and deposits Bank in which a check is deposited increase/gains both reserves and deposits
Banking system can create money up to a multiple of its excess reserves
Because the banking system cannot lose reserves.
Insufficient funds to meet its reserve requirements
Borrow reserves in the federal funds market
Commercial banks create money when they raise their interest rates
FALSE
Credit cards are a medium of exchange
FALSE
Individual commercials banks are limited in their ability to create money by lending because banking is a highly competitive industry
FALSE
The basic purpose of imposing legal reserve requirements on commercial banks is to assure the liquidity of commercial banks
FALSE
The primary reason commercial banks must keep required reserves on deposit at Federal Reserve Banks is to protect depositors from losses
FALSE
Profit-maximizing commercial bank
Liability attract funds at a low cost Asset management Liability management
Change in the behavior of households and commercial banks
Makes controlling the money supply more difficult
Multiple-deposit expansion of the banking system
Maximum money creating ability of the banking system
Money creating is reduced when
Public decides to hold more currency & Commercial banks decided to hold excess reserves
Simple money multiplier (m) assumes
Public does not hold any cash & banks fully loaned up hold no excess reserves
Commodity money
Refers to cows, gold, and silver
Required reserves
Reserve ratio set by the Fed Min reserve balance Checkable deposit liabilities x reserve ratio
Excess reserves
Single bank can lend only dollar-for-dollar with its excess reserves actual - required
Unregulated banking system
Vary the money supply to intensify the business cycle or destabilizes the economy
Commercial bank DESTROYS money
When deposits decrease and bank loans are repaid, banks sell government bonds to the public
Commercial bank CREATES money
When it uses its excess reserves to make a loan (monetizing an IOU) By bonds (exchanged for a check)
In a recession profit-motivated bankers will lend or create money in a way that causes the money supply to
decrease
In an economic boom, caused by demand-pull inflation, profit-motivated will lend or create money in a way that causes the money supply to
increase
In a regulated banking system
monetary policy is countercyclical
Currently, U.S. paper currency is issued by the
12 Federal reserve banks
Checkable deposits are included in M1 but not in M2
FALSE
Public (national) debt
Accumulation of federal budget deficits and surpluses over time Money owed by the federal government to holders of Treasury bills, Treasury notes, Treasury bonds, & US savings bonds Large public debt will not bankrupt the federal government liability to Americans as taxpayers and an asset to the owners of the government securities If the entire public debt is held internally by Americans, the liability would exactly offset the asset, or we would "owe it to ourselves"
Budget deficit (G > Tx)
Amount by which government expenditures exceed tax collections in a given year Makes up the difference by having the U.S. Treasury issue new U.S. securities Will be reduced and understated
Budget surplus (G < Tx)
Amount by which tax collections exceed government expenditures in a given year
A checkable deposit at a commercial bank is a(n) ________ to the depositor and a(n) ________ to the bank.
Asset/liability
100% reserve banking system
Banks are just a safe place to keep all the money Banks do not make loans with depositor's funds
Recession
Budget deficit automatically arises which is a countercyclical and stabilizing force in the economy
Demand-pull inflation (inflationary economic boom)
Budget surplus automatically arises which is a countercyclical, stabilizing force for the economy
Twelve Federal Reserve banks
Central banks, Quasi-public banks, Bankers for the commercial banks
Fiscal Policy
Changing the level of government expenditures and taxes to stabilize the economy and should be counter-cyclical
Expansionary fiscal policy
Close a recessionary gap by increasing aggregate demand
Contractionary fiscal policy
Close an inflationary gap (boom) by decreasing aggregate demand
Which of the following, cetreis paribus, would increase the money supply
Commercial banks buy bonds from the public
Discretionary/ Active fiscal policy
Congress actually meets to implement changes in government expenditures and/or taxes to close an output gap Actively manipulates aggregate demand
Federal Reserve Banks are owned by the Federal government
FALSE
Reserves
Deposits received by a bank but have not been loaned out Vault cash / deposits
Annually balanced budget
Destabilizes the economy, is not economically neutral, is pro-cyclical and will intensify the ups and downs
Externally held debt
Economic burden to Americans
Crowding-out of private investment
Economic burden to future generations
A budget deficit arises when federal government expenditures are increasing
FALSE
A contractionary fiscal policy is designed to decrease short-run aggregate supply
FALSE
A large U.S. public debt cannot bankrupt the federal government, leaving it unable to meet its financial obligations, because the government has the ability to decrease interest rates and increase investment spending
FALSE
Checkable deposits are assets of commercial banks
FALSE
Federal Reserve Act in 1913
Federal Reserve became the central bank of the United States ". . . to provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to establish a more effective supervision of banking in the United States . ."
Federal Reserve Notes
Form of current paper money in the United States
Administrative lag
Inability to get quick action on fiscal policy necause of the way Congress operates "congress" makes discretionary fiscal policy and an ineffective way to stabilize and destabilizes the economy
An expansionary fiscal policy is designed to ____ aggregate ______
Increase aggregate demand
The economy is initially operating at its potential real GDP. Because of a deteriorating international political situation the federal government decides to increase military spending by $21 billion. At the same time policymakers decide to change the level of taxes to maintain full-employment, non-inflationary real GDP. Assume the MPC = 0.75 and the full multiplier effect is in effect. The level of taxes should be
Increased by 28 billion MPC x Change in income = Change in spending .75 x ? = 21 billion ? = 28 billion
Economic burden of war
Is the same regardless if the budget deficit is financed by higher taxes or borrowing Opportunity cost of war is the forgone civilian goods (PPF) and lives lost
A tax reduction of a specific amount will be more expansionary the _____ the economy's MPC.
Larger
Checkable deposits are
Liabilities to commercial banks
Money eliminates the need for a coincidence of wants because it functions as a
Medium of exchange
3 Functions of money
Medium of exchange: buy and sell stuff Unit of account: Way to compare relative value (price tag) Store of value: any asset is a store of value
Problems with implementing fiscal policy in an open economy
Net export effect arises because international flows of financial capital are seeking the best interest rate Net export effect weakens the impact of fiscal policy
Flat money
No intrinsic value, face value > intrinsic value
If the U.S. federal budget were balanced next year, the size of the U.S. public debt would _____
Not change
Face value
Of silver dollar is $1 but the intrinsic value is $20, If intrinsic value is greater than the face value, then it is taken out of circulation (not using a silver coin at DD)
Economic efficiency
Overcomes the problems associated with barter, Promotes specialization and trade, Increases real output and standard of living
Non-discretionary Fiscal Policy
Passive or automatic
Non-discretionary fiscal policy
Passively manipulates aggregate demand
Positive GDP gap
Problem: Economic boom Demand pull inflation Actual GDP > Potential real GDP Unemployment rate < natural rate Solution: Decrease agg demand Policy: Contractionary fiscal policy creates a budget surplus
Negative GDP gap
Problem: Recession High unemployment (cyclical) Actual GDP < Potential real GDP Unemployment rate > natural rate Solution: Increase agg demand Policy: Expansionary fiscal policy creates a budget deficit
Congress implements changes in Govt spending and taxes for
Purposes other than stabilizing the economy
The commercial banking system can lend by a multiple of its excess reserves because
Reserves lost by one bank will be gained by another
A wave of consumer and business optimism stimulates the economy. As a result GDP exceeds the economy's full-employment real GDP and the unemployment rate falls to 3%. The economic boom causes demand-pull inflation. In this situation proper counter-cyclical discretionary fiscal policy would involve
Running budget surplus
Board of Governors
Seven people appointed by the President, with the confirmation of the Senate
When people hold some of their wealth as money because it enables them to transfer purchasing power from the present to the future money functions as a
Store of value
Federal Reserve independence
The Federal Reserve is an independent agency within the federal government Fed does not get its funding through the regular congressional appropriations process 14-year terms
Recognition lag
Time between the beginning of a problem and the realization that there is a problem "data"
Operational lag
Time it takes a fiscal policy, once enacted, to be put into operation
Federal Open Market Committee (FOMC)
To assess economic conditions and make decisions regarding the conduct of open-market operations
Fraction of deposits "in reserve"
commercial banks hold less in reserves than the amounts they owe their depositors Banks can create money by using their excess reserves to make a loan Banks are vulnerable to bank panics or runs
Near-monies
highly liquid financial assets that do not function directly as a medium of exchange
Government expenditure and tax programs, automatic stabilizers
insulate individuals from the impact of aggregate demand shocks Tax revenues, unemployment compensation, & welfare payments
The claims of the non-owners of a bank against the bank's assets are called
liabilities
Checkable deposits are money because they are
socially accepted
Money
socially accepted as a medium of exchange or as payment for goods and services
Balance sheet
summarizes the financial position of the bank Asset/ liability /owner equity
The less progressive the tax system
the less stable the economy
The more progressive the tax system
the more stable the economy because the greater the economy's built in stability the larger cyclical deficits and surpluses MPC becomes smaller and multiplier becomes smaller
Bank assets
uses of funds