Econ Test #2
What is the current monetary policy of the FED?
Current Money Supply: The Fed is again trying to stimulate economic activity through lower interest rates and increasing the money supply December 2008- December 2015 —> The Federal Funds Target ranges between 0% and .25% December 2015 - December 2018 —> the FED slowly is raising rates. Fed Funds target up to 2.25 - 2.5% July 2019 - today : the FED is lowering rates again... in July lowered to 2-2.25%... As october 30 2019, the FED funds target is 1.5% to 1.75% (it has been going down a quarter point at a time)
What is the difference between discretionary fiscal policy and automatic stabilizers? Give an example of each.
Discretionary fiscal policy = changes in government spending and taxation resulting from deliberate policy decisions. Ex. public works efforts and infrastructure spending Automatic stabilizers = tax and spending institutions (rules) that tend to increase government revenues and lower government spending during economic expansions, but lower revenues and raise government spending during economic recessions. Ex. income taxes, unemployment compensation, welfare/ food stamps
What is the aim of Monetary Policy?
Monetary policy uses some instruments or tools (see below) to change some intermediary variables like interest rates and money supply to achieve low inflation, moderate interest rates and economic growth (and employment). These last ones are the aims or objectives of the monetary policy. Since the Great Recession, central banks aim also to achieve financial stability by keeping risky lending at check and making sure that financial institutions have enough capital to stay afloat when there is a financial or economic downturn. It is important to recall that the Fed is required by the law to achieve these aims. The Federal Reserve Reform Act of 1977 required that the Fed shall "maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote the goals of maximum employment, stable prices, and moderate long-term interest rates." The first two is known as dual mandate of the Fed.
What kind of policy does Keynes prefer during a recession?
Keynes preferred Fiscal Policy.... He expected that during times of depression there would be a liquidity trap No matter how much the money supply increased, there would be no change in the interest rate He also felt that during a recession business expectations could also negate the efforts of expansionary monetary policy... businesses don't want to expand because of the business environment, regardless of interest rates
What was the response of the FED to the financial Crisis? How was it different than other monetary policy?
Since even a near-zero federal funds rate was insufficient to promote the lending required to kick start the economy, the Fed resorted to an unusual approach known as QE (buying other diverse financial assets, from banks and non-banks alike, such as MBSs). The main objective of such purchases is not an interest rate target but rather to flood the economy with more money, in hopes of provoking the necessary spending to create an economic stimulus. Quantitative Easing (QE): the purchase of financial assets including long-term bonds by the FED, creating more monetary reserves and expanding the money supply 3 rounds of QE between 2008 and 2014
According to Keynes when a business decides to invest the impact on the macroeconomy is much greater than that business' initial investment. What is that called and how does it work?
The Keynesian Multiplier is an increase in private consumption expenditure, investment expenditure, or net government spending raises the total GDP by more than the amount of the increase ex. The gov injects $200 million in a project to build thousands of affordable new houses aka business benefit (building supply) and wages and profits
If the Federal Government increased spending by $100 billion, or cut taxes by $100 billion what would be the effect on the macroeconomy? Which policy would be expected to have a bigger impact and why?
The government increasing spending by $100 will have a larger impact on the macroeconomy. Tax cuts have the lowest multiplier of all kinds of fiscal policy. Tax cuts on low-income households have a larger multiplier than tax cuts on the rich because low-income people have a larger marginal propensity to consume. Infrastructure spending has one of the largest multipliers but also one of the longest lag times.
Using your own words (and formulas if you want) explain the concept of the multiplier in the economy, discussing an increase in Government Spending.
The multiplier is the amount of times a dollar will circulate through the economy after it has been injected — after the first person spends the dollar, it becomes income for someone else and that person saves a percentage and spends the rest; the money they spend becomes someone else's income, and they save a percentage and spend the rest; this goes on and on until all the money has been saved. The multiplier measures how much a policy will impact spending, and usually the policy is a form of government spending. If the multiplier is 5 and government spending increases by $100, then the total spending will increase by $500. The mathematical expression is 1/(1-mpc), where mpc="marginal propensity to consume." Another way of expressing the multiplier is 1/mps, where mps=the percentage of money people save on average.
Be able to discuss bank regulation following the Great Depression and bank deregulation starting in the1980's. How was this a factor in the financial crisis?
The stock market crash of 1929 → regulations of banks, such as the Glass-Steagall Act, which separated investment banks from commercial banks. FDIC was set up. SEC was established.
Explain why total expenditure, total output, and total income must all equal each other in the macroeconomy.
Three ways to calculate GDP: value-added approach, income approach, and expenditures approach. The circular flow model illustrates how the expenditures approach and the income approach must equal each other -- there is a closed loop with goods and services flowing in one direction and income flowing in the opposite direction. Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy.
In the real world sometimes fiscal policy takes time to have an impact in the economy. Give an example of a timing problem with fiscal policy.
Time Lags: the time that elapses between the formulation of an economic policy and its actual effects on the economy ● Delayed responses make management of the economy less effective and it takes time for new policies to actually affect the economy Outside Time Lags: delayed effects of government policies Inside Time Lags: delays that occur within the government Examples of Inside Time Lags: Data Lag: the time it takes for the govt to collect information about economic problems such as unemployment Recognition Lag: Govt decision-makers may not see an event as a problem right away Legislative Lag: must convince president and congress before making legal changes to thebudget Transmission Lag: legal changes take time to show up in actual tax forms and government budgets B. American Recovery and Reinvestment Act (Obama Administration): ● Passed 3 months into recession to go in effect within 2 years ● Very hard to get stimulus started (70 billion available initially of 787 total) ● Automatic stabilizers like uninsurance were already in the works ● Infrastructure spending is great long term investment but has great lag time
What are good, economic reasons for deficits? Reasons to be careful about them?
benefits = increased AD / economic growth, makes use of surplus saving in recession, automatic stabilizers, finance public sector investment. Problems = increase in national debt, higher debt interest payments, future tax rises/spending cuts, potential "crowding out", potential inflation, may cause higher bond yields
What are the different types of Taxes we use in the U.S.? What is the difference between progressive, proportional and regressive taxes? Give examples of each.
proportional tax: imposes the same percentage of taxation on everyone, regardless of income. if the percentage tax rate is constant, the average tax rate is constant, regardless of income. This means that if a person's income goes up, the percentage of total income paid in taxes doesn't change. progressive tax: imposes a higher percentage rate of taxation on those with higher incomes. Progressive taxes use a marginal tax rate that increases as the amount of taxable income increases. Therefore, the percentage of income paid in taxes increases as income goes up. regressive tax: which imposes a higher percentage rate of taxation on low incomes than on high incomes. For example, if the state sales tax were 5%, the person with the lower income would pay a greater percentage of their total income in sales tax.
What was the long term impact of the financial crisis, on the economy and on policy?
(1) Even though in the long term the economy may be recovered, this recovery does not affect all victims equally. Some workers still struggle to find "and jobs that paid as well as the positions they had before the recession." (2) The financial crisis may lead to the legislation of regulative policies.
What determines money demand? (there are three types of demand for money)
(1) Transactions demand: We all need money to pay for goods and services that we want to purchase. Since each buying and selling is an economic transaction, we call transactions demand to holding money to use it in transactions involving purchasing goods and services. (2) Precautionary demand: People also hold money expecting that some unfortunate event may happen such that they need money to pay for the resulting expenses. In other words, people demand money for a rainy day. [Note that people can also buy insurance to protect themselves against some of these contingencies. In this case, money spent on insurance is part of transactions demand for money.] (3) Speculative demand: Another reason why people hold or demand money is that they want to invest their money in the investment opportunities that may emerge in the near future. The investment opportunity might be a stock or bond whose price is expected to rise (or fall)
How does the Fed affect the Money Supply (three ways)? What do they mainly do, historically, to changethe money supply?
1. Open Market Operations: buying and selling U.S. treasury bonds in the capital market by the Federal Open Market Committee FOMC: FED Board of Governors and 5 of the 12 regional FED presidents Most commonly used tool; others rarely applied 2. Changing the discount rate: the rate at which the FED lends reserves to its memberbanks a. Federal Funds Rate: the rate banks borrow and lend reserves on the very short term (overnight) i. The FED targets this rate when it conducts monetary policy 3. Changing the Reserve Requirement: the amount of reserves the FED requires to hold in reserve
Discuss the last two recessions in terms of monetary policy.
1. The 1970s and early 1980s were characterized by very rapid inflation. In this period, the Fed's goal was to counteract inflation by increasing interest rates substantially (contractionary monetary policy). While effective against inflation, this also caused severe recession. (2) During the financial crisis in 2007-2008, Fed used expansionary monetary policy by lowering the effective federal funds rate from over 5 percent in August 2007 to 0-0.25 percent by the end of 2008. It also lowered the discount rate from 5.75 percent to 0.5 percent. The Fed also purchased billions of dollars' worth of shaky assets, including MBSs and CDOs. Although it helped to support recovery, but that recovery was painfully slow.
If the Federal Government had to keep a balanced budget, what are the options for fiscal policy? What would Keynes say about requiring balanced budgets?
A balanced budget requires income (taxes) to equal spending (government spending + transfer payments), so for fiscal policy the options are only those where total taxes = total spending+transfer payments. For example, a government could tax $100 and spend $100, or it could tax $4,190 and spend $4,190, but it could not tax $100 and spend $99 or tax $4,190 and spend $5,000. Keynes argues requiring balanced budgets is an unnecessary constraint on fiscal policy that is harmful in an unstable economic system like capitalism. Since there are booms and busts, good fiscal policy should run a surplus during the booms (contractionary fiscal policy) and a deficit during the busts (expansionary fiscal policy). Maintaining a balanced budget is especially harmful in a recession, because no other organization in society can inject a sufficient amount of money into the economy to break out of the vicious cycle.
Discuss fiscal policy relative to The Bush Tax Cuts and the Obama Stimulus Package, with a focus on timing, lags and the multiplier. Be able to talk about them as general fiscal policy.
Both policies aimed to boost aggregate demand, bush using only tax cuts and obama using tax cuts and increased government spending. The bush tax cuts were enacted after a minor recession in 2001, versus the obama stimulus which was a direct response to a major recession (and also extended parts of the bush tax cuts). According to the textbook, the bush tax cuts (and tax cuts generally) lead to lower revenues and higher deficits, falling short of their intended effects and having a lower than expected multiplier. However, the stimulus package is credited with increasing aggregate demand enough to prevent a great depression-level crisis, having a multiplier slightly above 1 and significantly increasing employment.
What do both the Trump Tax cuts and the Obama stimulus have in common with the Bush tax cuts? Howare they different?
The trump tax cuts and obama stimulus are similar to the bush tax cuts in that they aimed to stimulate the economy, at least in part by decreasing taxes, which would increase aggregate income. The obama stimulus was a direct response to a major economic crisis, while the bush tax cuts were ostensibly a response to a minor crisis, and the trump tax cuts were not a response to crisis (garnering much criticism that the government should be taking in revenue before the next recession begins).
Why are the Trump tax cuts different from discretionary fiscal policy? (Hint: were we in a recession?).
The trump tax cuts are different from discretionary fiscal policy because they are intended to be a permanent change in tax rates and not a limited response to a specific issue with the economy's stability. A discretionary policy would mean changing spending or taxes for the purpose of having a definite effect on aggregate expenditure relative to the stability of the economy. Since the trump tax cuts occurred during an economic expansion they increased aggregate expenditure in the short term; discretionary fiscal policy would aim to do the opposite, or to save this type of policy for a recession.