Module 6

Automatic stabilizers are built into the economy.

They work to address recession and inflation on their own, without anyone having to make any decision.

Wait and See tag

The time it takes for policymakers to determine if fiscal policy is necessary.

Legislative tag

The time it takes to determine and approve a policy proposal.

Observation Tag

The time it takes to identify there has been an economic downturn.

As the economy slows, the government collects less in taxes and spends more on transfer payments, such as unemployment compensation and food stamps. As the economy expands, incomes rise and the government collects more in taxes and spends less on social programs.

Automatic Stabilizers (progressive income taxes, unemployment compensation, need-based government spending)

transmission tag

The time it takes for the approved policy to be carried out.

effectiveness tag

The time it takes for the policy to begin having an impact on real GDP and employment.

Change supply of bank reserve to affect interest rates, influence credit conditions and aggregate demands

YES

Contractionary fiscal policy

Fiscal policy used to decrease aggregate demand or supply. Deliberate measures to decrease government expenditures, increase taxes, or both. Appropriate during periods of inflation. - that decreases G or decreases taxes in order to decrease AD and GDP fiscal policy involves decreasing government spending and increasing taxes to decrease AD and GDP to decrease inflation.

What is money

Money is anything that serves 3 functions, medium of exchange, unit of account, and store of value.

discount rate

The interest rate on the loans that the Fed makes to banks

federal funds rate

The interest rate that other banks charge for these loans

Increase aggregate demand

its level of spending (G) to directly increase AD or it can indirectly increase consumption and investment, and therefore AD, by decreasing taxes. - increasing government spending and decreasing taxes

Money is created by commercial banks when

make loans

Effects of Increasing the Money Supply

more household and business spending lower interest increase employment increase inflation increase output increase aggregate demand

M1

most easily converted, most liquid assets,

Budget deficits occur when

government expenditures exceed revenues

Fiscal policy during a recession (aka expansionary fiscal policy)

increasing government spending and decreasing taxes to increase aggregate demand and GDP to decrease recessions.

Bank run

widespread panic in which great numbers of people try to redeem their paper money

Repurchase agreement (similar to expansonary but its not owned

yes

Federal funds rate

the rate banks charge each other for overnight loans

How Federal reserve affects money supply and interest rates...

the reserve requirement the discount rate and target federal funds rate open market operations

The government can implement contractionary fiscal policy by raising taxes or decreasing government spending to address inflation and stabilize the economy.

true

The most important function of the Federal Reserve is monetary policy

true

Traditionally Open market operations has been the Federal Reserve's most frequently used tool for conducting monetary policy.

true

increase in federal reserve lowers opportunity cost

true

The Federal Reserve has a dual mandate to achieve which of the following?

two goals of price stability and maximum sustainable employment

Functions of the Federal Reserve System

1) supervise and regulate banks and maintain stability in financial markets (examines banks regularly to identify and minimize bank risks, providing liquidity. Liquidity refers to the ease of obtaining cash..) 2) ensure an effective and efficient payments system (They distribute currency and coin, hold deposits, processes checks, and offer electronic forms of payment.) 3) conduct monetary policy.

Real GDP growth has started falling and unemployment has been edging upward. How can Congress and the president address these problems using fiscal policy? Select all that apply.

1. Decrease taxes 2. Use Expansionary Fiscal Policy 3. Increase Gov. Spending

How can Congress and the president use fiscal policy to stabilize the economy if it is growing too quickly and inflation is becoming a problem? Select all that apply.

1. Increase Taxes 2. Contractionary Fiscal Policy 3. Decrease gov. spending

Dual mandate

:Maximum employmentLow and stable inflation

Unemployment Compensation

A system of government payments to people who are out of work and looking for a job.

Functions of Banks and Other Financial Institutions

Accept deposits. Financial institutions accept and pay interest on deposits. They provide safekeeping and offer a small return on depositor's savings. Make loans. Financial institutions pool deposits and use the funds to make loans, at a higher interest rate than paid for deposits Process payments. Financial institutions perform additional agency functions for customers including processing checks, accepting direct deposits, and making payments and transfers.

M2

All of M1 + less immediate (liquid) forms of money to include savings, money market mutual funds, and small denomination time deposits.

Types of Financial Institutions

Bank: a financial institution that accepts deposits and makes loans Credit Union: a non-profit financial cooperative whose members can deposit and borrow money Savings and Loan: accepts savings and makes loans, often for home mortgages

Commodity Money vs. Fiat Money

Commodity money has value for what it can be used for in addition to serving as money. Fiat money has value only because is it accepted as a medium of exchange. fiat money. money without intrinsic value that is used as money because of government decree.

Contractionary Fiscal Policy

Decreases aggregate demand by: a decrease in G increase in taxes (decreases C) reduction in government transfers (decreases C)\ fiscal policy involves decreasing government spending and increasing taxes to decrease AD and GDP to decrease inflation.

The Role of Banks in the Economy

Financial intermediaries Money creation

GDP made of

GDP is made up of four components: consumption (C), investment (I), government spending (G), and net exports (exports minus imports). The federal government has direct control over the quantity of goods and services it purchases in any particular year (G). It also has indirect control over consumption spending (C) and businesses investment (I) through changes in the amount that households and businesses are taxed.

Monetary policy

Government policy that attempts to manage the economy by controlling the money supply and thus interest rates. The Fed influences the availability and cost of money and credit in the economy (the interest rate) to promote maximum employment and price stability; maximum employment and price stability.

If the inflation rate was above the Feds 2% target and continuing to rise, while unemployment was rapidly falling, the FOMC would likely respond by doing which of the following?

Increase the federal funds target rate and raise the interest rate paid on excess reserves

Expansionary Fiscal Policy

Increases aggregate demand by: an increase in G reduction in taxes (increases C) increase in government transfers (increases C) fiscal policy involves increasing government spending and decreasing taxes to increase aggregate demand and GDP to decrease recessions.

Nontraditional Monetary Policy

Interest on excess reserves: A monetary policy tool in which the Fed pays interest to banks on their excess reserve holdings, giving the Fed greater control over the federal funds rate.

buy and sell government securities

Open Market Operations

Members of the Board of Governors are appointed by the _________ and confirmed by the Senate.

President of the US

When money is used for exchanges, what happens to transaction costs?

REDUCES

Effects

Spur or restrain growth in overall demand for goods and services

The Federal Open Market Committee has the authority to decide the nations Monetary policy .

TRUE

The money supply in the United States is made up of currency, coins, and Checking accounts .

TRUE

When the Federal Reserve lowers the reserve requirement, the lending ability of banks increases .

TRUE

Monetary Policy

Target for the federal funds rate Communications

Government Protection of Financial Markets

The Federal Reserve Federal Deposit Insurance Company (FDIC) Comptroller of the Currency Securities and Exchange Commission (SEC)

Reserve Requirement

The amount of the bank's funds that must be held in its vaults, or on deposit at a Federal Reserve System (can be 3-5%)

Fiscal policy carried out by Congress and the president is known as discretionary fiscal policy. (when the government makes a decision to change taxes or spending to improve the economy.)

True

It would be a contractionary monetary policy action if the Fed increases the interest rate paid on excess reserves.

True

____________________________ decreases the money supply to prevent inflation. (increased in interest rate)

contractionary monetary policy

quantitative easing (QE)

technique used by the Federal Reserve to keep interest rates low and encourage banks to take on more loans to stimulate the economy - Fed. swaps money for assets other than T bills (most liquid in gov. security), to affect different and long term interest and better target particular parts in economy - increase bank supply at reserves, thus liquidity (more excess reserves)Nontraditional Monetary Policy Interest on excess reserves: A monetary policy tool in which the Fed pays interest to banks on their excess reserve holdings, giving the Fed greater control over the federal funds rate.

Aggregate demand

the amount of goods and services in the economy that will be purchased at all possible price levels; the demand for all goods and services (also known as gross domestic product).

effectiveness lag

the time needed for changes in policy to affect the economy (focus on automatic stabilizers)

Fed uses money supply and interest rate

to effect aggregate demand

The ability to pay interest

(Lets say they wanted to pursue contractionary policy), they would RAISE the interest rate, increase bank demand, upward pressure on short term interest rates, less willing to lend market interest rate, motivate banks to hold lower reserve

Characterisitcs of money

Divisible: buyers and sellers need to be able to divide money into smaller amounts to make change Portable: money needs to be easy to carry around Accepted: buyers need to be able to use money to make purchases throughout the economy Scarce: the supply of money needs to be less than everyone wants so that it has value Durable: money needs to last a long time

National debt

The sum of government deficits over time.

Money creation occurs through fractional reserve banking.

Fractional reserve banking is a system in which only a fraction of deposits in a financial institution are actually held in its vault and available for withdrawal.

Fiscal Policy Lags

Implementing fiscal policy is difficult because of the time that passes between recognizing a problem (like unemployment or inflation) and when the fiscal policy action has an impact on the economy. There are lags that delay the effects of fiscal policy and decrease its effectiveness.

Functions of money

Medium of Exchange: Money is accepted in exchange for goods and services. Unit of Account: The value of something is expressed in units of money (e.g., dollars). Store of Value: Money can be held on to and used later.

Open market operations

Open market operations refer to the purchase and sale of government bonds

Transmission Channels

Overall financial conditionsInterest ratesAsset pricesExchange rates Expectations of households and businesses

An ideal fiscal policy stimulus is _____.

Targeted, Timely, Temporary

Required reserve ratio

The minimum fraction of deposits banks are required by law to keep as reserves (r x total reserves)

Progressive Income Tax

The percentage of income paid in taxes will increase as income increases.

Since the Great Recession, Interest on excess reserves has been the Federal Reserve's most frequently used tool for conducting monetary policy.

True

expansionary fiscal policy by raising G or lowering taxes to address the recession and stabilize the economy.

True

Disposable income

When taxes are decreased, households have more disposable income to spend and therefore they spend more and C increases.

Reverse Repurchase Agreement (similar to contractionary but its rented NOT owned)

an agreement involving the purchase of securities by one party from another with the promise to sell them back

Total reserves - required reserves

excess reserves

An ____________ policy increases the money supply to encourage economic growth during periods of economic contractions or recessions (decreasein interest rates)

expansionary monetary policy

Government bonds are debt instruments issued by individuals.

false

The Board of Governors of the Federal Reserve System consists of twelve members.

false

Fiscal policy is the federal government's use of spending and taxing to stabilize the economy. Fiscal policy is used to pursue our national goals of economic growth, high employment, and stable prices. Fiscal policy is most effective when combating

fiscal policy

Borrowing and lending from other federal funds bank

led to federal funds interest rate

Effects od decreasing money supply

less household/businesspending decrease aggreagate demand decrease inflation and output higher interest

Higher reserve requirement

less money supply, increase in interest

The best case for effective fiscal policy is _____.

recession during a demand shock