ECON CH.15-16-17

What form did the Recovery Act take?

- infrastructure - transfer payments - tax cuts - Transfers to state and local governments (needed due multiple levels of government)

Three roles of money

- medium of exchange -store of value - unit of account

A public debt may crowd out investment spending which

reduces long-run economic growth.

implicit liabilities

spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics

Reserve ratio

the fraction of bank deposits that a bank holds as reserves

debt-GDP ratio

the government's debt as a percentage of GDP

Federal funds rate

the interest rate determined in the federal funds market.

Contractionary fiscal policy

fiscal policy that reduces aggregate demand

Assume that any money lent by a bank is always deposited back in the banking system as a checkable deposit and that the reserve ratio is 10%. The Fed purchases $100 million in Treasury bills. What is the effect on the value of checkable bank deposits?

$1 billion increase. Checkable deposits will increase by a maximum amount of $100 million x the money multiplier (10) = $1 billion.

Federal funds market

allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves

medium of exchange

an asset that individuals acquire for the purpose of trading goods and services rather than for their own consumption

Cyclically adjusted budget balance

an estimate of what the budget balance would be if the economy were at potential output

Near-moneys

financial assets that can't be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits

leverage

financing investments with borrowed funds

expansionary fiscal policy

fiscal policy that increases aggregate demand

U.S. government budget accounting is calculated on the basis of?

fiscal years

Deficits and debt are linked because...

government debt grows when governments run deficits

Rising debt may lead to...

government default, resulting in economic and financial turmoil.

Social Insurance

government programs intended to protect families against economic hardship

Automatic stabilizers

government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contractionary when the economy expands

Constractionary fiscal policies

increase the budget balance for that year, making a budget surplus bigger or a budget deficit smaller.

Monetary aggregate

an overall measure of the money supply

Money

any asset that can easily be used to purchase goods and services

Assume that $1000 in cash is deposited into First Street Bank and the required reserve ratio is 10%. Each time someone receives a bank loan, he or she keeps half of it in cash. If First Street Bank loans the maximum allowed, demand deposits will increase by $______ and cash will increase by $______ .

$450; $450. First Street Bank can loan out its excess reserves of $900. If the borrower keeps half in cash and half in demand deposits, each will increase by $450.

Fiscal policy multiple effect on the economy:

- Autonomous change in aggregate spending effect - Multiplier effect

Expansionary fiscal policy is implemented by:

- an increase in government spending - a cut in taxes - an increase in government transfers

Time lags on why fiscal policy needs to be taken with caution:

- it takes time to collect and analyze economic data to conclude a recessionary/inflationary gap exist. - it takes time for a government to develop a spending plan - it takes time to implement the plan (spend the money)

Contractionary fiscal policy is implemented by:

- reduction in government spending - increase in taxes - reduction in government transfers

Three main arguments against the use of expansionary fiscal policy

1. government spending always crowds out private spending (wrong principle) 2. government borrowing always crowds out private investment spending (valid sometimes) 3. government budget deficits lead to reduced private spending (raises important issues, but is not enough to believe fiscal policy doesn't work)

Assume that any money lent by a bank is always deposited back in the banking system as a checkable deposit and that the reserve ratio is 10%. The Fed purchases $100 million in Treasury bills. What is the size of the money multiplier?

10. The money multiplier is 1/reserve requirement = 1/0.1 = 10.

The Board of Governors

Appointed by the president and confirmed by the senate, oversee the Fedral REserve System from Washington, D.C.

Created in 1913, is the central bank of the United States?

The Federal Reserve

The two parts on which the Federal Reserve consists?

The board of governors and the 12 Regional Banks.

______ mean that a bank must have a certain amount of capital to protect depositors from loss.

Capital requirements

Currency in circulation

Cash held by the public

Expansionary Fiscal policy can...

Close a recessionary gap

Two categories in which bank separated in 1933:

Commercial banks (covered by deposit insurance) and investment banks (not covered)

A federal tax on gas is increased. Is this an example of an expansionary or contractionary fiscal policy?

Contractionary, because higher taxes will decrease disposable income, which will cause a decrease in consumption.

Several military bases around the country, which together employ tens of thousands of people, are closed. Is this an example of an expansionary or contractionary fiscal policy?

Contractionary, because it will reduce government spending.

monetary aggregate (M1)

Currency in circulation plus outstanding, traveler's checks, and checkable bank deposits

Assume that total reserves are equal to $200 and total checkable bank deposits are equal to $1,000. Also assume that the public does not hold any currency. Now suppose that the required reserve ratio falls from 20% to 10%. What is the maximum possible change in deposits in response to the reserve requirement decrease?

Deposits will increase by $1,000. The 10% decrease in the reserve requirement creates excess reserves of $100, which can generate deposits of $100 x 1/0.1 = $1000.

The length of unemployment benefits is increased. Is this an example of an expansionary or contractionary fiscal policy?

Expansionary, because it is an increase in transfer payments, which will increase disposable income, which in turn will cause an increase in consumption.

True or False? States that are required by their constitutions to balance their budgets are likely to experience fewer severe economic fluctuations than states not held to that requirement.

False, In recessions, states' tax revenue, which depends on consumer incomes, consumer spending, and producers' profits, falls. In order to balance the state budget, states have to cut spending or raise taxes, which deepens the recession. Without a balanced-budget requirement, states could use expansionary fiscal policy to lessen the fall in real GDP.

True or False? A system of commodity money uses resources more efficiently than a system of commodity-backed money.

False. Commodity-backed money uses resources more efficiently than simple commodity money, such as gold and silver coins, because commodity-backed money ties up fewer valuable resources. Although a bank must keep some of the commodity—generally gold and silver—on hand, it only has to keep enough to satisfy demand for redemptions. It can lend out the remaining gold and silver, which allows society to use these resources for other purposes.

Which type of money is most important/used most often in modern economies?

Fiat money is used most in modern economies.

Discretionary fiscal policy

Fiscal policy that is the result of deliberate actions by policy markers rather than rulers.

If there were a decrease in tax revenue, assuming everything else is equal, the size of the public debt would be ______ than it otherwise had been.

Greater. A decrease in tax revenue will increase the public debt.

The government borrowing to pay interest on its current debt, assuming everything else is equal, would cause the size of the public debt to be ______ than it otherwise had been.

Greater. More borrowing directly increases the size of the public debt.

Effect of a change in government transfers or taxes:

It shifts the aggregate demand curve by less than an equal-sized change in government purchases, resulting in a smaller effect on real GDP.

If the rate of growth of GDP increased at a faster rate, assuming everything else is equal, the size of the public dept would be ______ than it otherwise would have been.

Less. A higher rate of growth of real GDP implies that tax revenue will increase. If government spending remains constant and the government runs a budget surplus, the size of the public debt will be less than it would otherwise have been.

Two measures of money calculated by the Fed. Reserve

M1 or monetary aggregate

Although most bank accounts pay some interest, depositors can get a higher rate of interest by depositing their money in a certificate of deposit, or CD. The depositor pays a penalty for withdrawing the money before the CD comes due. A small CD would be counted in:

M2

Marginal Propensity to Consume (MPC) formula

MPC= Change in consumer spending / change in disposable income

Are financial assets like stocks and bonds part of the money supply?

No, because they're not liquid enough.

Should the budget be balanced?

No, economist dont believe government should be forced to run a balanced budget every year because this would undermine the role of taxes and transfers as automatic stabilizers.

Suppose you hold a gift certificate that is good at participating stores. Is the gift certificate money?

No. A gift certificate is not money because it can only be used to purchase a very defined set of goods and services. It can't be used to purchase any good or service.

What does reduce the budget balance for that year?

Other things equal, discretionary expansionary fiscal policies like: increaded government purchases of goods and services, higher government transfers, or lower taxes.

capital requirement

Regulators require that the owners of banks hold substantially more assets and the value of bank deposits. Bank's capital is equal to &% or more of their assets.

Lump-sum taxes

Taxes that do not depend on the taxpayers income.

True or False? Using deficit spending to eliminate a recessionary gap when the level of public debt is already high may decrease long-run growth.

True, A large public debt may decrease long-run growth because government borrowing may crowd out private investment.

True or False? The cyclically adjusted budget balance is a better measure of the long-run sustainability of government policies than the actual budget balance.

True, The actual budget balance takes into account the effects of the business cycle on the budget deficit. The cyclically adjusted budget balance factors out the effects of the business cycle and assumes that real GDP is at potential output. Because, in the long run, real GDP tends to potential output, the cyclically adjusted budget balance is a better measure of the long-run sustainability of government policies.

True or False? Federal disaster relief, which quickly disburses funds to victims of natural disasters, will stabilize the economy more effectively after a disaster than relief that must be legislated.

True, because it is is quickly disbursed is more effective than legislated aid because the time lag between the time of the disaster and the time when the aid is received by victims is short. So the policy will stabilize the economy after a disaster. In contrast, legislated aid is likely to entail a time lag in its disbursement, potentially destabilizing the economy.

If a fake $100 enters the US, who gets hurt?

U.S. taxpayers because counterfeit dollars reduce the revenues available to pay for the operations of the U.S. government

excess reserves

a bank's reserves over and above its required reserves

Expansionary fiscal policies make

a budget surplus smaller or a budget deficit bigger.

commodity money

a good used as a medium of exchange that has other uses. Ex. Gold and Silver

Deposit insurance

a guarantee that depositors will be paid even if the bank can't come up with the funds, up to a maximum amount per account. The FDIC currently guarantees the first $250 k of each account.

Store of value

a means of holding purchasing power over time

Unit of account

a measure used to set prices and make economic calculations

Bank run

a phenomenon in which many of a bank's depositors try to withdraw their funds due to fears of a bank failure

balance sheets effect

a reduction in a firm's net worth due to falling asset price.

T-account

a tool for analyzing a business's financial position by showing, in a single table, the business's assets (on the left) and liabilities (on the right) . Summarizes a bank's financial position.

Autonomous change in aggregate spending (AAS)

an initial change in the desired level of spending by firms, households, or government at a given level of real GDP

Central bank

an institution designed to oversee the banking system and controls the monetary base.

Discount window

arrangement in which the federal reserve stands ready to lend money to banks in trouble

Checkable bank deposits

bank accounts on which people can write checks

Contractionary fiscal policy can...

close an inflationary gap

Fiat money

derives its value from its official status as a means of payment. Ex. U.S. dollar

If retirees lived longer, assuming everything else is equal, implicit liabilities would be ______ than they otherwise had been.

greater. If retirees live longer the implicit liabilities increase because spending on programs for older Americans, such as Social Security and Medicare, will rise.

Commodity-backed money

has no intrinsic value; it's ultimate value is guaranteed by a promise that it can be converted into valuable goods, EX: paper money backed by gold or silver

Suppose you are a depositor at First Street Bank. You hear a rumor that the bank has suffered serious losses on its loans. Every depositor knows that the rumor isn't true, but each thinks that most other depositors believe the rumor. Assuming that the bank _____ deposit insurance this will _____ a bank run.

has; not lead to

Three forms fiscal policy can take:

increased government spending, increased transfer payments, and tax cuts.

multiplier effect

is the ratio of the total change of real GDP caused by an autonomous change in aggregate spending to the size of the autonomous change.

Subprime lending

lending to homeowners who dont meet the usual criteria.

Persistent budget deficits have long-run consequences because they lead to an increase in:

public debt

______ are rules set by the federal reserve that determine the minimum reserve ratio for banks.

reserve requirements

reserve requirements

rules set by the Federal Reserve that determine the minimum reserve ratio for a bank. In the U.S. the minimum reserve ration for checkable bank deposits is 10%

Fiscal year

runs from October 1 to September 30 and is labeled according to the calendar year in which it ends

Open-Market Operations (OMOs) by the Fed are the principal tool of monetary policy:

the Fed can increase or reduce the monetary base by buying government debt from banks or selling government debt to banks.

Bank reserves

the currency banks hold in their vaults plus their deposits at the Federal Reserve

Deficit

the difference between the amount of money a government spends and the amount it receives in taxes of a given period.

Discount rate.

the rate of interest the fed charges on loans to banks.

money multiplier

the ratio of the money supply to the monetary base.

Monetary base

the sum of currency in circulation and bank reserves.

Debt

the sum of money a governments owes at a particular point in time.

Money supply

the total value of financial assets in the economy that are considered money

Fiscal policy

the use of government spending and taxes to simulate aggregate demand.

Iiquid asset

when an asset can be quickly converted to cash without much loss of value.

Cicle of deleveraging

when asset sales to cover losses produce negative balance sheet effects on other firms and force creditors to call in their loans, forcing sales of more assets and causing further declines in asset prices.

securitization

when pools of loan are assembled and those pools are sold to investors.