Chapter 13-14 Fiscal and Monetary Policy

If the income tax rate is 25 percent and the tax rate on consumption is 10 percent, the tax wedge is

35 percent

In 2018 the federal budget has projected a ____ deficit

440 billion

What percent of U.S. govt debt is held by the rest of the world

48

Which of the following statements about U.S. government receipts is correct?

Federal receipts have ranged between 15 and 20 percent of gross domestic product for the past few decades

Inflation targeting works by

mandating the *central bank* to make a public commitment to achieving an explicit inflation target and explaining how its policy actions will achieve it

*TEST* The *three* objectives of *monetary policy* are

maximum employment stable prices moderate long-term interest rates

Two monetary policy instruments of the Fed; which one does it use

monetary base; interest rate at which banks borrow and lend monetary base overnight = *federal funds rate*

Vocab: Inflation rate targeting

monetary policy strategy in which the central bank makes a public commitment to achieve an explicit inflation target and explains how its policy actions will achieve it

If real GDP is less than potential GDP, outlays are ___ than receipts and there is a cyclical ____

more than; deficit

Result of labor tax on demand for labo

no change; (only depends on real wage rate)

taxes on capital income more powerful than those on labor income because they are levied on the​ ______, which makes them​ ______.

nominal interest​ rate; high as a percentage of the real interest rate

How does the Fed move the federal funds rate to its target

open market operations to adjust the quantity of bank reserves supplied

Largest part of govt tax revenue

personal income tax, social security tax

Fiscal Imbalance is the _____ value of the government's commitments to pay benefits minus the _____ value of its tax revenues

present; present

When the FOMC *lowers* the target federal funds rate, the Fed makes an open market ____ of securities to increase the supply of reserves of the banking system

purchase

*Test* The inflation rate rises when the Fed makes an open market _____ The supply of money _____ The interest rate ____

purchase; increases; falls

Vocab: Government Expenditure Multiplier

quantitative effect of a change in government expenditure on *equilibrium real GDP*

Vocab: Tax multiplier

quantitative effect of a change in taxes on *equilibrium real GDP*

Ch. 14 *TEST* The​ Fed's monetary policy complicates​ Congress's deficit cutting because if the Fed​ ______.

raised interest​ rates, rising debt payments would make it harder for the government to cut the deficit

If inflation is above or might move above the top of the comfort zone, the Fed considers ______; if inflation is below or might move below, the Fed considers ______

raising the federal funds rate target; lowering the interest rate

If a higher output gap is expected, the Fed considers

raising the interest rate because higher inflation is expected

Vocab: discount rate

rate on overnight loans from Fed to banks

*test* how to calculate real after-tax interest rate

real interest rate - (real interest rate + inflation rate) x ( tax rate) = real interest rate -(nominal interest rate x tax rate)

If the Fed *raises* the federal funds rate, other short-term interest rates and the exchange rate _____ The quantity of money ___ The supply of loanable funds ____

rise; decreases; decreases

*TEST* *MISSED* Suppose the Fed raises the federal funds rate. Other short-term interest rates and the exchange rate _____ the Quantity of money and loanable funds ____

rise; decrease

When the economy is below full employment, expansionary policy has what effect on price level

rises

When the Fed raises the federal funds rate, the U.S. interest rate _____ and the U.S. dollar

rises; appreciates

After a tax increase, at the new equilbrium quantity of labor the before-tax wage rate ____ and after-tax wage rate____

rises; falls

*****TEST**** When the Fed raises the federal funds rate, it makes an open market ____ Other short-term interest rates and the exchange rate ___ The quantity of money and supply of loanable funds _____. The Fed would do this during ____

sale; rise; decrease; inflationary gap, to slow down real GDP growth and inflation

With an end goal to *decrease aggregate expenditure*, the Fed ____ securities

sells

When the Fed raises the federal funds rate, the Fed ___ securities in an open market operation. When would the Fed do this

sells; during an *inflationary* cycle, (will result in *lower long-term interest rates* so *higher* investment, consumption, and expenditure)

how do inflation rate and tax rate on interest income compare

the *higher* the inflation rate, the *higher* the true tax rate on interest income

The primary current debate with regard to monetary policy

the *timing* on *withdrawing the money stimulus*

Vocab: cyclical surplus or deficit

the budget balance that arises because *tax revenues and outlays are not at their full-employment levels* the actual surplus or deficit - structural surplus/deficit

Ch. 14 *test* Ongoing government budget deficits complicate the​ Fed's monetary policy because​ ______

the deficit *puts pressure on interest rates to​ rise*, which makes it harder for the Fed to conduct monetary​ policy

tax cuts will not pay for themselves if

the economy lies to the left of the max point on the Laffer curve

Vocab: Tax wedge

the gap created between the before-tax and after-tax *WAGE RATE* alt: the gap between what *a buyer pays and a seller receives*

*Test* Generational Accounting is an accounting system that measures

the lifetime tax burden and benefits of each generation

Vocab: Fed's Dual Mandate

the mandated goals to achieve *stable prices* and *full employment*

*test* Calculation for Fiscal Imbalance

the present value of the government's commitments to pay benefits - the present value of its tax revenue

The incentive to supply labor depends on

the quantity of goods and services that an hour of labor can buy

Vocab: core inflation rate

the rate of increase in the *core PCE deflator*(excludes food/fuel) which is the *Fed's operational guide*

Vocab: Impact lag

the time it takes from passing a tax or spending change to its effects on real GDP being felt

Vocab: Recognition Lag

the time it takes to figure out that fiscal policy actions are needed

Vocab: Fiscal stimulus

the use of fiscal policy to increase production and employment

Vocab: Law-making lag

time it takes Congress to pass the laws to cut taxes/increase spending

Largest and fastest growing section of govt spending

transfer payments

During the financial crisis *Congress* authorized the use of *government funds* to buy

troubled assets

Discretionary changes in govt expenditure or taxes have multiplier effects of ____ magnitude; the tax multiplier is likely ____

uncertain; larger than 1

Vocab: Monetary policy instrument

variable that Fed can directly control/very closely target

Whether the Government Expenditure Multiplier is greater than or less than 1 depends on

whether increased aggregate expenditure or increased government borrowing is stronger; the crowding out effect is strong enough to make the government expenditure multiplier less than 1

A stimulus package centred around a​ *one-time consumer tax rebate* is likely to have a​ ______ supply-side effect because​ ______.

​larger; all of government expenditure is added to aggregate demand but part of the tax rebates is saved

​$150 billion worth of government spending would have a​ ______ effect on aggregate demand than​ $150 billion worth of tax rebates because​ ______ .

​larger; all of government expenditure is added to aggregate demand but part of the tax rebates is saved

Vocab: Fiscal Imbalance

an attempt to measure the scale of the government's true liabilities

The Fed translates the goal of stable prices as

an inflation rate of *between 1-2% per year*

*TEST* Which is an example of *automatic* fiscal policy

an unemployment benefit program

The​ Fed's primary goal is price stability because​ ______ .

attaining this goal helps to attain its other two goals of maximum employment and moderate​ long-term interest rates

A fall in real GDP that results from a decrease in personal income tax receipt is an example of ____ fiscal policy

automatic (pay attention to word *receipts*; the *rate* has not been changed)

**TEST** Difference between automatic and discretionary fiscal stimulus

automatic affects demand; *discretionary* affects *demand and supply*

*test* A fall in real GDP that results in a decrease in personal income tax receipts is an example of​ ______

automatic fiscal policy

Taxes work as a(n) ____ fiscal policy during business cycle because they ____ during an expansion

automatic; increase

Needs tested spending works as a(n) ____ fiscal policy to dampen business cycle because it ____ during a recession

automatic; increases

The federal funds rate is the rate at which

banks can *lend to EACH OTHER*

Vocab: Fall in Asset Prices

banks suffer a capital (equity) loss.

Do changes in tax rates impact the economy through changes in AD or AS

both

When the FOMC decides to *increase* the money supply it orders the New York Fed to ____ securities

buy (open market purchase)

By _____ the Fed is able to change bank reserves and the federal funds rate

buying ( during inflationary gap) and selling (during recessionary gap)

With an end goal to *increase aggregate expenditure*, the Fed ____ securities

buys

When the Fed lowers the federal funds rate target, it ___ securities in an open market operation to lower the federal funds rate. Other short-term interest rates and the exchange rate ____. The quantity of money and the supply of loanable funds ____. The long-term real interest rate _____. Consumption and investment expenditure _____

buys; also fall; increase; falls; increase

When the Fed lowers the federal funds rate, the New York fed ____ securities. The lower interest rate makes the U.S. dollar _____; net exports ______

buys; depreciate; increase

*TEST* How do the Fed's monetary policy actions influence the exchange rate?

by changing the *U.S. interest rate differential*

*test* In normal​ times, the Fed hits its federal funds rate target by​ _______ , and by​ ________ at the target rate.

creating a​ "corridor" that limits the movement of the federal funds​ rate; supplying the quantity of reserves demanded

If the economy is experiencing a recessionary gap, Congress can ____ to *increase aggregate demand*

cut taxes of increase expenditure

In the market for bank reserves, if the federal funds rate target is higher than the federal funds rate, the Fed will take action to ________ reserves.

decrease the *supply of*

A rise in the federal funds rate (Fed sells securities) ___ aggregate expenditure. real GDP, and inflation

decreases

A rise in the federal funds rate _____ the quantity of money and bank loans

decreases

A rise in the interest rate _____ the quantity of money demanded

decreases

When the government taxes the nominal interest rate minus the inflation rate, (aka real interest rate), the true tax rate ____

decreases

Result of labor tax on supply of labor

decreases supply of labor --> smaller eq. quantity smaller potential GDP

*Test* A tax on labor income __________. The equilibrium quantity of labor __________. At the new equilibrium quantity of labor, the before-tax wage rate _________ and the after-tax wage rate __________.

decreases the supply of labor; decreases rises; falls

Easing by the Fed _____ the U.S. interest rate differential, which *weakens* the dollar and strengthens the euro; net exports and aggregate demand ___

decreases; increase (U.S. exports are cheaper with depreciated dollar)

A rise in the federal funds rate (Fed sells securities) _____ bank reserves and the quantity of deposits and bank loans. The equilibrium real interest rate ____

decreases; increases

For economies *below* the T value on Laffer curve, a decrease in the tax rate ____ tax revenue

decreases; positive relationship on the "correct" side (below T point)

Ending the Bush tax cuts​ ______ short-run aggregate supply and​ ______ potential GDP

decreases; decreases

Increasing taxes on business and investment​ ______ short-run aggregate supply and​ ______ potential GDP.

decreases; decreases

*****TEST**** A rise in the federal funds rate​ ______ reserves and​ ______ the quantity of deposits and bank loans created. The quantity of money demanded​ ______. Consumers and firms spend​ ______.

decreases; decreases decreases, less

Vocab: Run on the bank

depositors lose confidence in the bank and massive withdrawals of deposits occur.

Vocab: Large currency drain

depositors withdraw funds and the bank loses cash reserves leading to liquidity crisis

The phrase "the dollar under pressure" means the dollar is

depreciating

The main reason why the govt expenditure multiplier is small

govt expenditure funded by borrowing increases te demand for loanable funds and raises the real interest rate *so investment decreases*

The lower the real interest rate, the ____ is the amount of investment (investment = firm spending, not savings)

greater

The lower the real interest rate, the ____ is the amount of consumption expenditure and the _____ is the amount of saving

greater; smaller

*test* Other things remaining the same, the lower the real interest rate, the _________ is the amount of investment and the _________ are net exports.

greater; greater

In the federal funds market, the higher the federal funds rate, the ____ the quantity of overnight loans supplied and the ____ the quantity of overnight loans demanded

greater; smaller

low employment usually brings _____ inflation

higher

If the FOMC had followed the Taylor rule, the federal funds rate would have been _____ from 2001-2005 and ___ in 2006/2007

higher; lower

An open market purchase leads to an ____ in the money supply which causes interest rates to ____ and investment spending to ____

increase fall rise

A discretionary fiscal stimulation package that would avoid a budget deficit is a simultaneous and equal​ ______.

increase in govt expenditure and increase in taxes

If a country were on the wrong side of the Laffer curve, a *decrease* in taxes would have what effect

increase in tax revenue

*TEST******* taxes and needs-tested spending work as automatic fiscal policy to dampen effects of business cycle fluctuations, taxes _____ during expansion and needs-tested spending ___ during a recession

increase; increase

A lower exchange rate makes U.S. exports cheaper and imports more costly, so net exports _____ Easier bank loans reinforce the effect of lower interest rates on aggregate expenditure. Aggregate demand ______, which _____ real GDP and the price level relative to what they would have been had the Fed not lowered the federal funds rate. Real GDP growth and inflation speed up.

increase; increase; increases

*TEST* *MISSED* govt deficits *automatically* _____ during recessions and _____ during expansions

increase; decrease

result of tax cut

increased employment, increased output; does *not* increase tax revenue as predicted by Arthur Laffer

A cut in the federal funds rate (Fed buys securities) _____ aggregate expenditure, real GDP, and inflation

increases

A fall in the federal funds rate (Fed buys securities) ___ the quantity of money and bank loans

increases

A fall in the interest rate ____ the quantity of money demanded

increases

Increased govt spending on infrastructure: ____ real interest rate _____ demand for loanable funds _____ real GDP _____ govt budget deficit _____ number of jobs

increases increases increases OR decreases increases increases OR decreases depending on effect on real GDP

When the Fed undertakes *quantitative easing*, aggregate demand and the monetary base_____ When the Fed undertakes *quantitative tightening*, aggregate demand and the monetary base ____

increases; decrease

A fall in the federal funds rate (Fed buys securities) ____ bank reserves and the quantity of deposits and bank loans. The equilibrium real interest rate _____

increases; decreases

*test* in the long run, a tax cut ____ *the money wage rate* and ____ *short run aggregate supply*

increases; decreases; (economy returns to full-employment equilibrium with higher employment and real GDP than before)

A fall in the exchange rate: ____ aggregate demand _____ unemployment _____ inflation

increases; decreases; increases (price levels rise and real GDP increases)

*test* in the short run, a tax cut _____ *aggregate demand* and ____ *employment*

increases; increases

Expenditure on alternative energy and the​ nation's infrastructure​ ______ short-run aggregate supply and​ ______ potential GDP.

increases; increases

Expenditure on college tuition​ ______ short-run aggregate supply and ​ ______ potential GDP

increases; increases

**TEST* A fall in the federal funds rate​ ______ the supply of bank loans and the supply of loanable​ funds, and​ ______ the equilibrium real interest rate.

increases; lowers

*TEST* What would be a fiscal policy the govt might use if the economy *is operating at too high level of output*

increasing tax rates

What 3 things does the Fed monitor to decide federal funds rate

inflation unemployment real GDP

The main influences on the FOMC federal funds rate decision are​ ______

inflation unemployment output gap

A rise in the interest rate is indicated by

inflation above 2% unemployment below nautral Real GDP above potential

A fall in interest rate is indicated by

inflation below 1% unemployment above natural real GDP below potential

Vocab: Short term bill rate

interest rate paid by US govt on Treasury bills

Vocab: Long term bond rate

interest rate paid on bonds issued by large corporations; influences firm's investment decisions

How do the present value and interest rate compare

inversely; the lower the interest rate, the higher the present value must be to gain future value

The Fed focuses on core inflation more heavily than overall inflation because core inflation​ ____

is a better indicator of the direction in which monetary policy should lean because it is less volatile than the total CPI inflation rate

The U.S. labor market *tax wedge* is _____, but relatively ____ compared to other industrialized countries

large; small

***TEST* If the FOMC order the New York Fed to *sell* securities, the money supply curve will shift to the ____ and equilibrium interest rates will _____

left; rise

If real GDP exceeds potential GDP, outlays are ___ than receipts and there is a cyclical ____

less than; surplus

The Federal Reserve Act of 2000 says that the Fed​ "shall maintain​ ______ growth of the monetary and credit aggregates commensurate with the​ economy's ______ potential to increase​ production."

long run; long-run

If the federal funds interest rate remains within the corridor and the demand for reserves is​ unchanged, an increase in the quantity of reserves will _____ the federal funds rate

lower

The higher the federal funds rate, the _____ is the quantity of reserves demanded

lower

**TEST** The lower the real interest rate, the ___ the exchange rate; the ____ are exports; the ____ are imports

lower exchange rate; greater exports; smaller imports

U.S. income tax rate compared to rest of industrial world

lower than the rest of the industrial world

The Fed reacts to a recessionary gap by_____ the federal funds rate and ____ securities

lowering; buying

*test* how to calculate true tax rate

(real interest rate - real after tax interest rate) / real interest rate x 100 the *tax paid as a percentage of the real interest rate*

When the Fed lowers interest rates by *buying securities*, does the *demand for loanable funds* or the *quantity of loanable funds demanded* increase?

*Quantity of loanable funds demanded* increases *as a result of increase in supply of loanable funds and lower interest rates*

If the federal funds rate *target* is *higher* than the federal funds rate, the Fed will ____ the *supply of bank reserves* It will ____ securities

*decrease*; sell (double-check)

The Fed has been criticized for _____ the money supply too much as a result of the financial crisis

*expanding*

In the *short-run* a policy of *monetary stimulus* lead to ____ money growth ____ interest rates _____ output

*faster* money growth *lower* interest rates *higher* outputs

By changing real GDP and the price level relative to what they would have been without a change in the federal funds rate, the Fed influences its ultimate two goals: _____ and ______

*inflation rate* and *output gap*

The function of the Taylor rule is to

*link* the Fed's target for the *federal funds rate* to *economic variables* including *inflation and output gap*

*Test* Supply-side supporters of the Laffer curve claim that higher taxes can

*lower overall govt revenues*

*TEST* Supply-side economists point to the Laffer curve as evidence that *higher* taxes may

*lower* overall govt revenue

According to supply-side theory, fiscal policy makers can combat the impact of recessions by

*lowering tax rate*

The *real after tax interest rate* subtracts

*real interest rate - income tax paid on interest*

How did the FOMC change interest rates in reaction to 2007-2009 recession

*reduced* the target rate steadily in 2008

*TEST* *MISSED* The long-run effects of new infrastructure expenditure are a ____ in the *money wage rate* and a ____ in *potential GDP*

*rise in money wage rate* *increase of potential GDP*

The Fed's open market operations determine the _____ for reserves

*supply*

Fiscal policy has supply-side effects because

*taxes on labor* weaken the incentive to work, decreasing employment and *potential* GDP *and* *taxes on interest* weaken the incentive to save and invest, decreasing *growth rate of real GDP*

*TEST* Generational Imbalance is the division of _____ between current and future generations, assuming that the current generation _____

*the fiscal imbalance*; *will enjoy the existing levels of taxes and benefits*

Who makes the Fed's interest rate decision

Federal Open Market Committee

The ripple effects that follow a change in the federal funds rate change what 3 components of aggregate expenditure

1. Consumption Expenditure 2. Investment 3. Net Exports

*TEST* How to find tax wedge on graph

1. Find equilibrium point on LS + tax and LD curve 2. Find point on original LS curve with the same labor value as new equilibrium point 3. Calculate difference of Real Wage Rate (y value) between points

In response to the financial crisis, the Fed and Treasure took what 3 policy actions

1. Open market operations 2. Extension of deposit insurance 3. Troubled Asset Relief program

Four alternatives to improve fiscal imbalance

1. Raise income taxes 2. Raise social security benefits 3. Cut social security benefits 4. Cut federal government discretionary spending alternative is printing money, but this would cause serious inflation

Fiscal stimulus policies are hampered by

1.Uncertainty about multipliers *and* 2.The three time lags (Recognition lags, Law-making lag, impact lag)

Federal receipts have ranged between ___ of GDP for the past few decades

15-20

In June​ 2017, ______ of U.S. government debt was held by the rest of the world.

6.1 trillion

Fiscal imbalance estimate in 2014

68 trillion (4 times annual GDP)

The Fed sets the federal funds rate target and announces changes on ____ dates each year

8

Current generation will pay ____% and future generation will pay ____% of fiscal imbalance

83% ; 17%

the US fiscal year runs from

Oct 1 - Sept 20

Fiscal policy attempts to achieve all of the following objectives except​ ______. A.a stable money supply .B.price level stability C.sustained economic growth D.full employment

A This is the job of *monetary* policy

What is a present​ value? Choose the statement that is *incorrect* A. a tool used to compare the value of an amount of money at one date with that at a later date B.a tool used to​ calculate, with​ certainty, how much the government will need to invest today to pay the future pensions and medical benefits of older Americans C.an amount of money​ that, if invested​ today, will grow to equal a given future amount when the interest that it earns is taken into account D.a tool that enables us to compare dollars today with dollars in 2050 or any other future year

B

Fiscal Policy is controlled by ____. Monetary policy is controlled by _____

Congress (taxes and expenditure); the Fed (federal funds rate and bank reserves)

The FOMC has responsibility of monetary policy, and reports to _____

Congress and public

*TEST* 3 main events that can put a bank under stress

Fall in asset prices Large currency drain Run on the bank

Vocab: Volcker Rule

First highlight of Dodd-Frank Wall Street Reform and Consumer Protection Act (aka Financial Stability Act): restricts amount that banks may invest in hedge funds and private equity funds to a max of 3% of capital

Effects of tax cuts or govt expenditure increases

Increases government borrowing raises real interest rates cuts investment

What two monetary policy strategies are designed to enable the central bank to manage inflation expectations and reduce uncertainty

Inflation Targeting The Taylor Rule

Vocab: Federal Funds rate

Interest rate in the federal funds market in which banks borrow and lend overnight; The Fed's monetary policy instrument ***

****** Would most economists be for or against a balanced federal budget mandate?

Most economists would *not be in favor of* a balanced federal budget mandate. A balanced budget mandate ties the hands of government and *does not allow for automatic and discretionary fiscal policy action to move the economy out of a recession.* However, many might support a structurally balanced budget that still allowed for cyclical imbalances. In this case, the budget would be in surplus during strong economic times and in deficit during recessions. Over the long term it would balance, but not necessarily be balanced in any given year.

The ____ appoints members and the Chairman of the Board of Governors of the Fed, which is responsible for _____

President; Monetary Policy

Discretionary fiscal stimulus actions are seriously hampered by what 3 things

Recognition lag Law-making lag Impact lag

effect of new tax code that subtracts inflation from interest rate before calculating taxable income

SLF curve *shifts right*; equilibrium quantity of loanable funds in greater, interest rate is lower

Vocab: Orderly Liquidation Authority

Second highlight of Dodd-Frank Wall Street Reform and Consumer Protection Act (aka Financial Stability Act): mpowers the FSOC to determine that the liquidation of a financial institution is necessary for the stability of the financial system. If a forced liquidation occurs, the FDIC can use an Orderly Liquidation Fund to manage it.

*TEST* The source of the fiscal imbalance

Social Security pensions and Medicare benefits

Chapter 14 *test* Why are the goals of monetary policy in *conflict* in the short term and *harmony* in the long-term?

Taking an action that is designed to *lower the inflation rate* and achieve stable prices might mean *raising interest​ rates*, which *lowers employment and real GDP* in the short run

**TEST* *TEST* *TEST* *TEST* calculation for tax revenue using investment, saving, govt expenditure, exports, and imports calculation for budget balance using investment, saving, govt expenditure, exports, and imports

Tax Revenue = Investment + Government Expenditure + Exports - Saving - Imports Budget = Tax Revenue - Government Expenditure

Vocab: Beige Book

The Fed's publication that summarizes the data it gathers and describes *current state of economy*

*TEST* How can the Fed fight a combination of *rising* unemployment and *rising* inflation

These goals *cannot be addressed simultaneously*

Congress passed the *Dodd-Frank Act of 2010* which included the ____ and _____ and established

Vlockler Rule and Orderly liquidation Authority; The Financial Stability Oversight Council (FSOC)

*TEST* Relationship between federal funds rate and employment and inflation

When the Fed cuts the interest​ rate, aggregate demand​ increases, unemployment​ decreases, and inflation rises. So the Fed cuts the interest rate if it deems the unemployment problem to be worse than the inflation problem. When the Fed raises the interest​ rate, aggregate demand​ decreases, inflation​ falls, and unemployment increases. So the Fed raises the interest rate if it deems the inflation problem to be worse than the unemployment problem.

***TEST*** fiscal policy action that might increase investment and speed economic growth is​ ______ , which works by​ ______ the real interest rate paid by borrowers and​ ______ the real interest rate earned by savers and suppliers of loanable funds.

a decrease in the tax on interest​ income; *lowering* interest rate paid by borrowers; *raising* real interest rate earned by *savers*

A tax on consumption is equal to

a drop in *real wage rate*

Vocab: Discretionary fiscal policy

a fiscal policy action initiated by an act of Congress

Vocab: Automatic fiscal policy

a fiscal policy action that is triggered by the state of the economy with not action by government

If unemployment is below natural level, the Fed may onsider

a higher interest rate because a higher inflation rate is expected

Two interest rates create a​ "corridor" that limits the movement of the federal funds rate. The​ _______ acts as a cap on the federal funds rate and the​ _______ acts as a floor

discount rate = cap interest rate on reserves = floor Because a bank can borrow from the Fed at the discount​ rate, it will not borrow from another bank unless the interest rate is lower than or equal to that rate.​ So, the discount rate acts as a cap on the federal funds rate. And because a bank can hold reserves at the Fed and earn the interest rate on​ reserves, it will not lend to another bank unless the interest rate is higher than or equal to that rate.​ So, the interest rate on reserves acts as a floor on the federal funds rate.

*TEST* When an economy is *below full employment* and the government has a budget​ deficit, that deficit​ ______

exceeds the structural deficit (includes cyclical)

The recovery from the 2008-9 recession was slow because

extreme uncertainty about the future kept business investment low

When the Fed purchases securities banks have *more* reserves, so they deposit money by making loans. (*Recall banks create money by making loans*) The short-term interest rate ____ and the quantity of money demanded _____

falls; rises

______ is used to achieve macroeconomic objectives

federal budget

Monetary policy includes adjustments in ____ so as to change ____

federal funds rate; aggregate demand

The Fed sets a low interest rate to

fight recession

Vocab: Macroprudential Regulation

financial regulation to lower the risk that the financial system will crash

Vocab: Taylor rule

formula for setting the federal funds rate FFR = 2 + INF + 0.5(INF-2) + 0.5GAP INF = inflation rate INF = 2% deviation GAP = output gap

Primary goal of most governments' fiscal policy

full employment

One of the primary goals with *fiscal policy* is; one of the primary goals with *monetary policy* is

full employment keeping price levels stable

*Test* Vocab: Laffer curve

shows relationship between *tax rate* and *tax revenue collected*

We would expect the *absolute value* of the tax multiplier to be _____ than that of the government purchase multiliplier

smaller

The higher the federal funds rate, the ____ is the quantity of *reserves* demanded

smaller (banks want to lend)

effects of tax cuts on aggregate supply

strengthen incentives to work and invest, so increase aggregate supply usually by more than aggregate demand

*TEST* *MISSED* A budget deficit needs govt action to decrease it when the deficit is ____ A deficit will disappear when the economy moves back to full employment when the deficit is ____

structural; cyclical

**TEST* A budget deficit that needs government action to remove it is a ________ deficit. A ________ deficit will disappear when the economy moves back to full employment.

structural; cyclical

govt debt is measured as the

sum of past govt budget *deficits* MINUS sum of past govt budget *surplus*

An open market sale of government securities by the Federal Reserve shifts the _________ reserves curve _________

supply of; leftward

An open market sale of government securities by the Fed shifts the _____ reserves curve to the ____

supply; left

Difference between tax on labor and tax on capital

tax on capital lowers incentive to save: *slows growth rate of real GDP*; tax on labor *lowers supply of labor and potential GDP*

Two items in the government budget that change automatically in response to the state of the economy

tax revenues needs-tested spending

Supply-side economics emphasizes the role that ___ plays in the economy

taxes

Vocab: Structural surplus or deficit

the *budget balance* that would occur *if economy were at full employment*