econ final pt 3 FINAL
Reasons why aggregate demand might grow slowly
- federal govt reduces budget deficit by cutting back its purchases and raising taxes, or recessions in other countries might cause a decline in us exports
3 Reasons Aggregate expenditure increases
1) As the population grows and incomes rise, consumption will increase over time 2) As the economy grows, firms will expand capacity, and new firms will be established, increasing investment spending 3) An expanding population and an expanding economy require increased government services, such as more police officers and teachers, so government purchases will expand.
2 reasons for bubbles
1) Investors may be caught up in the enthusiasm of the moment an, by failing to gather sufficient information, may overestimate the true value of the stocks 2) An investor may expect to profit from buying stocks at inflated prices if the investor can sell them at even higher prices before the bubble bursts
Covid-19 recession introduced temporary lending facilities that were separated into two categories
1) Liquidity facilities - build on the Fed's original role as a lender of last resort to the commercial banking system by extending credit to issuers of commercial paper, money market fund shares, and other assets connected to the shadow banking system and by aggressively lending in the repurchase market 2) Credit Facilities - allows the Fed to provide funds directly to non- financial firms and state and local governments by either granting them loans or by buying their bonds
2 Types of Interest Rates
1) Loanable funds model --> long-term real rate of interest (corp. bond, new factories/ office buildings_ 2) The money market mode short-term nominal rate of interest -when analyzing monetary policy, economists focus on the short term rate because its what is most affected by Fed Policies
Why is the demand curve for money downward sloping
1) Money has one characteristic --> you can use it to buy goods, services, or financial assets 2) Money has one undesirable characteristic --> either earns zero interest rate or a very low interest rate as the interest rate increases ppl will hold less money --> the opp. cost for holding money is low
The Goals of Monetary Policy
1) Price Stability 2) High Employment 3) Stability of financial markets and institutions 4) Economic Growth
Banks hold substantial reserves for 3 reasons
1) interest rate the Fed pays on reserves is low - investment is risk free - interest rate is competitive with the returns on other. safe short term investments a bank can make 2) during 2008 and Covid high levels on uncertainty of the financial system led many banks to increase their liquidity 3) large banks are required to be more liquid than they were before 2007
2 Important factors of the economy
1) the economy experiences continuing inflation, with the price level rising every year 2) the economy experiences long-run growth, with the LRAS curve to the right every year
Shifts in the money demand curve
1. changes in the aggregate price level 2. changes in real GDP - decrease in real GDP will shift left - increase in real GDP will shift right 3. changes in credit markets and banking technology 4. changes in institutions
Managing federal funds rate
2008 - Fed began paying banks interest on their reserve holdings this interest rate is close to the feds target
Troubled Asset Relief Program (TARP)
A 2008 Federal government program that authorized the U.S. Treasury to loan up to $700 billion to critical financial institutions and other U.S. firms that were in extreme financial trouble and therefore at high risk of failure result from the failure of the Lehman Brothers
Inflation Targeting
A framework for conduction monetary policy that involves the central bank announcing its target level of inflation provides an outline for carrying out monetary policy
countercyclical policy
A policy that tends to move the economy in an opposite direction from the forces of the business cycle. Such a policy would stimulate demand during the contraction phase of the business cycle and restrain demand during the expansion phase.
people's ability to innovate
An assumption of the new growth theory is that the growth rate of labour productivity depends on ___
movement along the aggregate production function
An increase in labour hours will lead to a ___
2.0; real GDP
Between 1926 and 2016, the average growth rate of real GDP per person in Canada was ___ percent a year. During this period, ___ grew at a faster rate than the population
higher; higher
Ceteris paribus, an increase in labour productivity results in a ___ real wage rate and ___ potential GDP per hour of labour
How do interest rates affect aggregate demand?
Consumption - lower interest rates on loans increase spending on durables by reducing monthly payments - higher interest rates reduce household spending on consumer durables and increase the return to saving Investment -higher interest rates on corporate bonds or on bank loans make it more expensive for firms to borrow so they take on less investment projects - increase stock prices - increases firms spending -mortgage rates increase so the cost of buying a house increases net exports -if interest rates in the US rise relative to interest rates in other countries US assets will become more desirable - as the dollar increases net exports will fall and interest rates in the US will decline
How is the federal fund rate determined?
Determined by the demand for and supply of reserves changes result in changes in interest rates on short term financial assets such as treasury bills
128
During 2016, the country of Economia had real GDP of $115 billion and the population was 0.9 billion. In 2017, real GDP was $105 billion and the population was 0.85 billion. In 2016, real GDP per person was ___
High Employment
Employment Act of 1946 - Federal Govt responsibility to promote stable working conditions Promotes max production and purchasing power
Why doesn't the Fed target both the money supply and interest rate?
Fed cannot target both at the same time forced to choose between the 2 as it can only achieve a combo of the interest rate and money supply that represents equilibrium in money market
Using monetary policy to fight inflation
Fed uses contractionary policies to keep aggregate demand from expanding into inflation
Expansionary monetary policy
Fed uses this to reach a goal of high employment Federal Reserve Policy of decreasing interest rates to increase real GDP
Freddie Mac
Federal Home Loan Mortgage Corporation
Fannie Mae
Federal National Mortgage Association
Taylor Rule Equation
Federal funds target rate = Current inflation rate + Equilibrium real federal funds rate + (1/2)* Inflation gap + (1/2) Output gap
exports
Firms in the United States sell goods and services to the rest of the world
goods market
Firms sell and households buy consumer goods and services
Total expenditure on final goods and services equals GDP
GDP = C + I + G + X - M.
GSEs
Government Sponsored Enterprises; Fannie Mae and Freddie Mac
government expenditure
Governments buy goods and services from firms and their expenditure on goods and services
decreases for a given level of technology
If capital per worker decreases, real GDP per hour of labour
$40 an hour
If real GDP is $800 million and aggregate labour hours are 20 million, labour productivity is ___
$12.50 an hour
If the money wage rate is $15.00 an hour and the price level is 120, the real wage rate is ___
$6.00 an hour
If the real wage rate is $10.00 and the price level is 60, the money wage rate is ___
Increased
In 2016, Northland had real GDP of $4.21 billion and a population of 2.98 million. In 2017, real GDP was $4.59 billion and population was 2.97 million. Between 2016 and 2017, Northland's standard of living ___
high population growth resulting form the increase in real GDP per person
In the classical growth theory, economic growth eventually stops due to ___
raises; increases
In the labour market, an increase in labour productivity ___ the real wage rate and ___ the level of employment
Contractionary Monetary Policy
Increasing interest rates to reduce inflation
Can the Fed eliminate recessions?
Its very hard for the Fed to complete successful expansionary policy to regulated real GDP the best the Fed can do it keep recessions shorter and milder
The Taylor Rule
John Taylor Links the Fed's target for the federal funds rate to economic variables
subprime loans
Loans made to homeowners who do not qualify for standard (prime) home loans. Subprime loans can have high fees, and costly prepayment penalties that "lock in" the borrower to a high interest rate.
Predicted value for the federal funds target rate
Predicted Federal Funds Target Rate = 1% +2% + ( 1/2 x -1%) + (1/2 x -1%) = 2%
Fed as a dual mandate to attain what 2 goals?
Price Stability + High Employment both are explicitly mentioned in the Employment act bc Congress incorporated similar language in the Fed Reserve Act
money wage rate/price level
Real wage rate formula
Equilibrium in the money market
Simplicity --> the MS Supply curve is a vertical line --> changes in interest rate have no effect on the quantity of money supplied if the fed increases the money supply the money supply curve will shift right and the equilibrium interest rate will fall
Economic Growth
Stable economic growth--> allows households and firms to plan accurately and encourages firms to engage in the investment funds
Stability of Financial Markets and Institutions
The Fed promotes the stability of financial markets and institutions so that an efficient flow of funds from savers to borrowers will occur 2008 - Fed took steps to ease liquidity problems of these financial firms bc the Fed believed these problems were increasing the severity of the recession
zero lower bound problem
The constraint placed on the ability of a central bank to stimulate the economy through lower interest rates by the fact that nominal interest rates cannot be driven lower than zero (because if interest rates were negative, people would be unwilling to put their money into banks due to the fact that deposit balances would decrease over time due to the negative interest rate.)
diminishing returns
The decreasing slope of the aggregate production function reflects
Surplus; falls
The equilibrium has a real wage rate of $15 per 150 billions of hours. If the real wage is $20 an hour, a labour ___ occurs and the real wage ___
reversed; slower
The gap between real GDP per person in Canada and Hong Kong has ___ since 1980. During this period, the growth rate of real GDP per person in Canada has been ___ than in Hong Kong
technological innovations encouraged by the patent system
The industrial Revolution in England was largely the result of ___
net exports
The value of exports (X ) minus the value of imports (M)...(X - M)
potential GDP
The value of real GDP when all the economy's labor, capital, land, and entrepreneurial ability are fully employed
classical growth theory
Which theory of economic growth argues that, in the long run, people do not benefit from growth?
monetary policy
actions the Fed takes to manage the money supply and interest rates to achieve its macroeconomic policy objectives
temporary lending facilities
allow loans to businesses other than commercial banks that can borrow from the Fed using discount loans with these the Fed was able to ensure that funds flowed from firms to state and local governments
final good (or service)
an item bought by its final user during a specified time period.
intermediate good
an item that is produced by one firm, bought by another firm, and used as a component of a final good or service.
Fed Forecasts
b/c it takes a while to change monetary policy the Fed sets policy according to future forecasts
Gross
before deducting the depreciation of capital
Money Market
brings together the demand and supply for money
imports
buy goods and services from the rest of the world
How does the Taylor Rule work?
estimate of the value of the equilibrium real federal funds rate which should be around 2% target for federal funds rate so it is = to the sum of the inflation rate, the equilibrium real federal funds rate, and two additional terms
GDP market value
goods and services are valued at their market prices
Compensation of employees
he payments for labor services. It is the sum of net wages plus taxes withheld plus Social Security and pension fund contributions
Real GDP
he value of final goods and services produced in a given year when valued at the prices of a reference base year
overnight reverse purchase facility
helps provide a floor under overnight interest rates by acting as an alternative investment for a broad base of money market investors when rates fall below the interest on reserve balances (IORB) rate.
Adjustments to Equilibrium
if the fed increases the money supply ppl are more likely to use the money to buy short term financial assets -treasury bills -deposit the money in banks to earn interest
procyclical policy
increases the severity of the business cycle
IOER
interest on excess reserves paid by the Fed
Federal Funds Rate
interest rate banks charge each other on loans in the federal funds market short term - just overnight
factor markets
markets where services of the factors of production are bought and sold, such as the labor markets, the capital market, the market for raw materials, and the market for management or entrepreneurial resources
net
means after deducting the depreciation of capital.
expenditure approach
measures GDP as the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports
income approach
measures GDP by summing the incomes that firms pay households for the factors of production they hire—wages for labor, interest for capital, rent for land, and profit for entrepreneurship
credit crunch
occurs when there is a lack of funds available in the credit market, making it difficult for borrowers to obtain financing, and leads to a rise in the cost of borrowing
Lags + delays for monetary policy
of the Fed is to late to recognize a recession has started they cant implement new policy quick enough to do good usually a lag or delay between policy change and its effect on real GDP, employment, inflation, + other variables
business cycle
periodic but irregular up-and-down movement of total production and other measures of economic activity; phases are expansion and recession; turning points are peak and trough
Using the exchange rate to compare GDP in one country with GDP in another country is problematic because ?
prices of particular products in one country may be much less or much more than in the other country.
Domestic product
production within a country
investment
purchases add new capital equipment and the additions to inventories
Real GDP per person
real GDP divided by the population
What happens when the Fed increases money supply
short-term interest rates must fall until it reaches a level at which households and firms are willing to hold the additional money
Repurchase Agreements
short-term sales of government securities with an agreement to repurchase the securities at a higher price
Depreciation
the decrease in the value of a firm's capital that results from wear and tear and obsolescence
The Lucas wedge
the dollar value of the accumulated gap between what real GDP per person would have been if the 1960s growth rate had persisted and what real GDP per person turned out to be
Net investment
the increase in the value of the firm's capital.
GDP
the market value of all final goods and services produced in a country in a given time period.
Demand for Money
the relationship between how much money people want to hold and the interest rate
Gross investment
the total amount spent on purchases of new capital and on replacing depreciated capital
Consumption expenditure
the total payment for consumer goods and services
Nominal GDP
the value of goods and services produced during a given year valued at the prices that prevailed in that same year
Monetary Policy Targets
these can affect directly and that in turn affect variables such as GDP employment price level Main monetary policy targets 1) Money Supply 2) Interest Rate
Price Stability
when the overall level of prices changes slowly or not at all helps mitigate inflation and recessions
Gross profit
which is a firm's profit before subtracting depreciation, is one of the incomes included in the income approach to measuring GDP.
national product
which is the value of goods and services produced anywhere in the world by the residents of a nation
