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*