Macroeconomics Unit 3
Increase in money supply=
(1/r)* Excess reserves
Expansionary Monetary Policy
(Easy) increasing the money supply to decrease interest rates, which increases consumption, investment and net exports and therefore increases AD; used to fight unemployment/low demand
Contractionary Monetary Policy:
(Tight) decreasing the money supply to increase interest rates, which decreases consumption, investment and net exports; which decreases aggregate demand; used to fight inflation
The Goals of the Fed
*Full Employment (4-5% unemployment), Economic Growth (2.25-3% growth in real GDP), *Price Stability/Low inflation: 2-3% inflation, Exchange Rate Stability, Interest Rate Stability, Financial Markets Stability: no SIFI failures (Systematically Important Financial Institutions, sometimes said to be TBTF-Too Big to Fail)
The discount rate is the interest rate paid by...
...banks that borrow from the fed
Banks increase the money supply when they...
...make loans
Prior to 2008, the Federal Reserve moved the federal funds rate higher and lower using...
...open market operations
If there is slack in the resource market...
...production costs will decline, and AS shifts right.
AS: As the Price Level increases...
...real GDP increases
There is tightness in the resource markets if...
...real GDP is above potential GDP.
There is slack in the resource markets if...
...real GDP is below potential GDP
Sales/Excise taxes are often...
...regressive, because a higher percentage of low-income people's earnings are exposed to the tax
Whereas the federal reserve used to set a single target for the FFR, it now...
...sets a range that is 25 basis points wide
Government spending is determined by...
...the Congress and is independent of any economic variables
The chairman of the Fed is chosen from...
...the board and has a 4-year term
The Fed targets...
...the federal funds rate
In the 'ample reserves' framework of monetary policy...
...the federal reserve moves the FFR into the target range primarily by adjusting the IOER rate
If AD increases...
...the price level (inflation) and real GDP increase
If AS increases...
...the price level (inflation) decreases and real GDP increases
AD: As the price level increases...
...the total quantity of an economy's final goods and services demanded decreases
How many nonrenewable terms?
14
Board of Governors
7 members appointed by the President of the U.S. and confirmed by the Senate
Income
As domestic ___ rises, so does consumption, and some spending is for foreign goods. Imports rise and net exports would drop. If foreign ___ rises, they'd buy more of our exports, and net exports would rise.
How does arbitrage ensure that the FFR does not drop too far below the IOER rate?
Banks have an incentive to borrow at the FFR and deposit at the IOER.
Most money in the US is held in the form of...
Checking Accounts
Who is responsible for Fiscal Policy?
Congress
Discretionary fiscal policy
Congress acts at its discretion to change government spending or taxes
FOMC (Federal Open Market Committee):
Decides monetary policy
Which of the following best describes how the federal reserve might use the current framework to increase employment during a recession to achieve its maximum employment objective?
Decrease the target range for the FFR
Quantitative Easing
Differs from open market operations in that the Fed buys financial assets from financial institutions other than short term Treasury securities. The assets may be longer term or more risky.
Adjustments in the stance of monetary policy are communicated as a change in which of the following?
FFR
What is the name of the banking system where banks loan out more money than they have on deposit?
Fractional reserve system
International trade effect
Higher prices mean prices for goods and services produced in the U.S. are not competitive with foreign made goods
Interest rate
If the cost to borrow increases, businesses will spend less
Exchange Rates
If the dollar got stronger, net exports would fall
Capacity Utilization
If there's lots of excess capacity, firms can expand production without spending
Expectations
If you think there's going to be a recession and you will lose your job, your consumption decreases
Prices
In relative terms, higher domestic prices make foreign goods more attractive, so net exports drop
Long-term effects:
In the long run, tightness in the resource markets, particularly in the labor markets, will drive up production costs, and shift AS to the left.
Cost push inflation
Increases in production costs cause firms to raise prices to avoid losses.
Demand pull inflation
Increases in total spending that are not offset by increases in the supply of goods and services cause the average level of prices to rise.
Excess reserves=
Legal reserves-required reserves
Demographics
More people will spend more, but spending patterns are also influenced by the composition of the population
What financial innovation, popularized in the late 90s, might have allowed lenders to accept a greater amount of risk?
Mortgage back security
Why is the Long Run Aggregate Supply Curve Vertical?
Most economists think the LR AS is a vertical line at the potential level of GDP. In the long run, wages and other resource costs would fully adjust too price changes.
Government policies
Net exports may drop if Japan puts restrictions on U.S. goods allowed into Japan, for example.
Technology
New ___ stimulates business spending because firms must stay current to compete
In the ample reserves framework, what rate acts like a floor for the FFR?
ON RRP
medium of exchange
People will accept money in exchange for goods and services. Barter requires a double coincidence of wants - you have to find somebody who both has what you want AND wants what you have in order to trade
Discount Rate
Rate at which the Fed lends to eligible institutions: Increasing the ___ decreases the money supply
Required reserves=
Reserve requirement ratio*checkable deposits
Net Exports
Spending by Foreigners
Consumption
Spending by households
Store of Value
Store purchasing power
Factors that affect AS
TREES
TREES
Technology, Resource Prices, Expectations, Economic Growth, Supply Shocks
Interest on excess reserves (IOER)
The Fed lowers the ___ to decrease the federal funds rate. If the federal funds rate drops below ___, banks will borrow at the federal funds rate and deposit the funds in their accounts at the Fed, driving the federal funds rate up
Overnight Reverse Repurchase agreements (ON RRP):
The Fed sells securities to eligible institutions, and buys them back the next day for a higher price. Eligible institutions will not lend below this rate, because they can get this rate risk-free from the Fed. The rate on ___ acts as a floor for the federal funds rate.
Why does short run AS slope up?
The prices of inputs tend to be fixed by contracts (like labor contracts), so firms can increase the prices of their output more quickly than their costs rise. This increased profitability per unit causes them to produce more output as the price level rises.
Progressive income tax
The tax rate rises as income rises in percentage terms.
Thinking in terms of a supply and demand graph, how did the Financial Crisis move the supply of reserves?
They moved the supply curve right into the flat portion of the demand curve
Interest rate effect
When the price level increases, interest rates rise and (household and) business spending declines
Cost of Capital Goods
___ are goods that firms buy to use in making other goods. These goods give no pleasure in themselves, but only 2 are desirable because they make something else. If the cost of capital goods increases, business spending decreases.
Legal reserves
assets defined to be legal reserves (vault cash and deposits at the Fed)
Open Market Operations
buying and selling Treasury and government agency securities to change the money supply. To increase the money supply, the Fed buys bonds. (the most important tool)
Fiscal Policy
changing government spending and taxes to stabilize the economy
Monetary Policy
changing the money supply to stabilize the economy
Contractionary fiscal policy
decreasing government spending and increasing taxes to decrease AD, used to fight inflation
Expansionary fiscal policy
increasing government spending and decreasing taxes to increase AD; used to fight unemployment
Effects of deficits
may raise interest rates if financed by borrowing. Higher interest rates
Functions of Money
medium of exchange, unit of account, store of value
Automatic Stabilizers
policy that is automatically set in motion to increase government spending /decrease taxes to fight unemployment or decrease government spending/increase taxes to fight inflation. Congress does not act
Investment
spending by business firms
Federal Funds Rate
the interest rate that banks charge each other for reserves. All other interest rates move with this rate.
Reserve requirement
the ratio of a bank's deposits that must be kept on reserve and cannot be lent out. Increasing the ___ decreased the money supply. (least used tool) The Fed did away with the ___ in 2020
Regressive tax
the tax rate decreases as the tax base changes.
Proportional tax
the tax rate does not change as the tax base changes.
Aggregate Demand
the total quantity of an economy's final goods and services demanded at different price levels
Aggregate Supply
the total quantity of an economy's final goods and services produced in the economy at different price levels. Anything that affects the costs of production will affect___
Unit of Value
to measure the value of goods and services
Wealth Effect
when the price level goes up, and the amount of income and financial assets that people have doesn't change, they can't buy as much