ECON 311 Exam 3 Review

What monetary policy is implemented in Zero Lower Bound?

Unconventional: Credit Easing & QE

Supply Shocks

Unexpected events that changes supply of a product w/ a sudden change of price - Unemploy Rate > Natural Unemploy Rate

Liquidity Traps

When consumers & investors hoard cash rather than spending/investing during low int rates

Janet Yellen article?

"I do think there's a path to bring down inflation while maintaining what I think all of us would regard is a strong labor market," Yellen said. "And the evidence that I'm seeing suggests we are on that path."

Limitations of the Taylor Rule

1) Can help w/ times of steady growth & inflation but not w/ an economic crisis 2) Lack of application towards risk mgmt policies

Money Demand and Interest Rates are ___________ related

Inversely

Aggregate Demand Shifts

1. Changes in Consumption 2. Changes in Investment 3. Changes in Gov Spending 4. Changes in Net Exports

Short Run AS Shifts

1. Changes in Labor 2. Changes in Capital 3. Changes in Raw Materials 4. Changes in Tech

Main ideas of Activists (3)

1. Economy doesn't equilibrate quickly enough at Natural Real GDP 2. Flexible policy works w/ smoothing business cycle

3 Factors drive Inflation

1. Expected Inflation 2. Persistent Output Gap 3. Inflationary Supply Shocks

How do liquidity traps affect the Fed?

1. Fed can raise int rates to motivate people to invest 2. Quantitative Easing - Inject money into economy

Causes of Demand-Pull Inflation

1. High levels of economic growth 2. Country close to productive capacity 3. Total demand rises faster than the total supply 4. Rising government spending 5. Rise in investment from firms

Causes of Cost-Push Inflation

1. Higher Costs of Prod 2. Increased Labor Costs 3. Natural Disasters

FFR ________ on Demand Shocks and _________ on Supply Shocks

1. Rises 2. Falls

Assumptions of the Keynesian View

1. Sticky Wages & Imperfect Competition 2. Money Demanded is dependent on Interest Rate

Main ideas of Anti-Activists

1. Wages & prices are flexible enough to allow economy to equilibrate 2. MS growth rate remains constant at avg annual growth rate of GDP - Assumes V & MS is constant

% Change in Money Supply

= % Avg Annual Growth rate in Real GDP - % Growth rate in Velocity

Liquidity Preference Theory

Investors demand higher interest rate or premium risk LT maturities

Different views on fiscal policy? (2)

A. Keynesian: Expansionary fiscal policy can stimulate economy B. Fiscal policy causes no long term increase in real output

Current & previous Unemployment Rate?

Current: 3.5% Previous: 3.6%

Current & Previous FFR

Current: 4.75% - 5% Previous: 4.5% - 4.75%

Current & previous Inflation Rate

Current: 5% Previous: 6%

Negative Shocks

Decreases output, increasing price - Reduces equilibrium GDP

Output Gap

Difference between actual output & potential output

Why is the LRAS Vertical

Due to natural rate rate of output

Classical View

Emphasis of free mkts that are self-regulatory & little gov intervention - LRAS is inelastic

Keynesian View

Emphasis over expansionary fiscal policy & output can be below full capacity

Equation of Exchange

Explains total amt of money that changes hands is equal to the total money value of goods that change hands

Credit Easing

Focus on asset side & ease credit thru purch of assets - Fed buys private securities or makes loans to financial institutions to stimulate lending

Positive Shocks

Increases output, causes prices to decrease - Increase equilibrium GDP

Money Demand has what type of relationship with interest rates

Inverse (negative)

What is the Taylor Rule?

Links Fed's target for FFR to the current inflation rate, real equilibrium federal funds rate, inflation gap, & output gap

Demand for Real Money Balances

Md / P = f(i, Y)

MV = PQ

Money Supply * Velocity of money = Price * Quantity

Speculative

Money held rather than buying assets - People hold larger money amts when int rates are low

Transaction

Money is needed to buy goods - Medium of Exchange

Precautionary

Money needed for financial emergencies

Demand-Pull Inflation

Occurs when pressure on prices follows a shortage in supply "Too many dollars chasing too few goods"

What is the shared assumption of Classical & Keynesian?

People & companies have behave rationally w/ rational expectations

Non-Activists

People against fiscal & monetary policies - Permanent & stable rule-based

Activists

People who support monetary & fiscal policies should be used to smooth business cycle

Rule-based Framework

Policymakers follow pre-specified plan for circumstances - Offers time-consistency - Short term public demand matches long term desires

Discretionary Framework

Policymakers have flexibility in circumstances - Serves better w/ uncertain environment

Real Money Balances

Quantity of money expressed in the quantity of goods & services it can buy Equation: (M/P)

Zero Lower Bound

Refers to belief that interest rates cannot be lowered past zero

Cost-Push Inflation

Results from rise of prices due to rise in cost of wages & raw materials OR a negative supply shock

What did recent US Economic Data portray?

Showed continued signs of cooling in areas such as inflation & consumer spending - Soft landing still possible

Why is Keynes view superior

Shows that velocity is NOT constant but positively related to interest rates

___________ developed the Liquidity Preference Theory while __________ developed the Equation of Exchange

a. John Maynard Keynes b. Milton Friedman

Sticky Wages

nominal wages that respond slower even in times of high unemployment & slow to rise even in times of labor shortages

Taylor Rule Equation

r = p + 0.5y + 0.5(p 2) + 2 r = FFR p = Rate of Inflation y = % deviation between current real GDP & LT linear GDP