Econ Exam 3

short v. longterm monetary policy

-short-run, R changes and affects N; assume inflation was constant (sticky)- N= R + pi + pd -long-run, inflation changes and N changes (not R); money does not affect big parts of economy, real thing, money is neutral; in long-run we let inflation fully adjust (reflected in graph) --confusing: Fed reserves expansionary policy- more money (first stimulate econ, fall interest, long-run: interest rates higher due to higher inflation

Aggregate supply curve

-total quantity of goods and services that firms produce and sell at any given price level -in the long-run, AS curve is vertical, SR- AS curve slopes upward

Four Steps for Analyzing Macroeconomic Fluctuations

1. Decide whether the event shifts the AD curve or AS supply curve (or perhaps both) 2. decide direciton of shift 3. use diagram to determine the impact output and price level in short run as well as movement from a short-run equilibrium to long-run equilibrium

problems in controlling the money supply

1. Fed does not control the amount of money that households choose to hold as deposits in banks (ex.: a lot of people withdraw money, bank loses reserves, money supply falls) 2. Fed does not control the amount the bankers choose to lend (lend less- money supply falls)

shifters of LR Aggregate Supply Curve

1. Labor A. min wage increases, E decreases, LRAS dec. B. unemployment benefits inc., E decreases, LRAS dec. C. Labor Union power increases, E decreases, LRAS decreases 2. capital A. physical and human capital increases, LRAS increases 3. technological advances- LRAS increases (can also be changes in tech- new production processes, change production methods) 4. natural resources increases, LRAS increases

closer look gov't budget surplus

SS increases; Keynesian economics -government stimulates economy during hard times, bad econ, increase spending and dec. taxes; good econ, gov't spending decreases, taxes increase)

Stagflation

a period of slow economic growth and high unemployment (stagnation) while prices rise (inflation)

100% reserve banking system

every coin in bank has to stay in bank -reserves= dollars and coins in bank vaults -currency= dollars and coins in hands of public -deposits (demand)= dollars in checking accounts T account where the total is on both sides ($100 in example)

growth equation

gm + gv= gp + gy gm= growth rate of money supply gv= growth in velocity gp= inflation gy= economic rate of growth

commodity money

has intrinsic value -gold, silver, cigs, ramen -item would have value even if it were not used as money

fiat money

has no intrinsic value -dollars, continentals, greenbacks, confed. notes

liquidity

how easily an asset converts to cash without loss of purchasing power; a house might be a store of value, but it's not a very liquid asset because you can't immediately buy a bowl of ice cream with it very easily. Cash is the most liquid asset because you can use it immediately.

why AS curve is vertical in long run

in LR, an economy's production of goods and services (real GDP) depends on its supplies of labor, capital, and natural resources, and on the available technology used to turn these factors of production . into goods and services; change in price level does not affect this -graphical representation of classical dichotomy and monetary neutrality

What ensures that the quantity of money the Fed supplies balances the quantity of money people demand?

in the long run, money supply and money demand are brought into equilibrium by the overall level of prices

interest rate on savings account

interest rate is the same as others; in actual life, interest rates decrease leads to decrease in deposit vault savings

investment incentives policy effects

investment tax credit= gives tax advantage to any firm building a new factory or buying a new piece of equipment; demand curve shifts to the right; higher interest rates and greater saving

demand for loanable funds

investment; households and firms who wish to borrow to make investments; family takes out mortgage to buy new home or firm borrow to buy new equipment and factories

monetary neutrality

irrelevance of monetary changes for real variables

Credit Card Responsibility and Disclosure Act of 2009

limited rates credit card companies could charge - creates shortage- credit card companies lend less than demanded -savers (credit card companies) are worse off -borrowers are worse off for people who can't get credit cards; better off for people with credit cards (lower interest)

The Price Level and Net Exports: The Exchange-Rate Effect

lower price level in US lowers the US interest rate- US investors seek higher returns by investing abroad, mutual finds tries to convert dollars to ___, increases supply of dollars in market for foreign-currency exchange -increased supply of dollars to be exchanged- depreciated dollar; real exchange rate changes -foreign goods become more expensive relative to domestic goods -Americans buy less from other countries, US imports of goods and services decreases, foreigners buy more, US exports increase; NET exports increase -increase in quantity of goods and services demanded

Money's three functions in the economy

medium of exchange, unit of account, store of value

contractionary monetary policy

monetary policy designed to decrease AD, decrease output, increase unemployment

expansionary monetary policy

monetary policy designed to increases aggregate demand, increase output, decrease unemployment

Fisher effect equation

nominal interest rate = inflation rate + real interest rate -Fed increases rate of money growth, the long-run result is both a higher inflation rate and a higher nominal interest rate -nominal interest rate adjusts to expected inflation which moves with actual inflation in the long run (not really true short run)

bank/demand deposits

(also called demand deposits) money kept in a bank, like checking accounts; we call these "demand deposits" because banks are usually required to provide access to the money in those accounts immediately on request (in other words, on demand).

real asset

(sometimes called a physical asset) a claim on a tangible object that gives the owner the right to use it as they wish. A house is a real asset that its owner can sell or rent out, and a factory is a real asset that a business can use to earn profits.

3 causes for aggregate demand sloping downward

- all else equal, a decrease in the economy's overall level of prices raises the quantity of goods and services demanded and vice versa 1. wealth effect (households)- (real wealth rises) P level dec., C dec., Q ad decreases (Pigou effect) 2. Interest rate effect- (interest rates fall) firms (P level increases), all else equal, Qd money increases (people desire to carry more money to buy goods); ppl pull money out of saving... Ss/Id, R increases, I decreases, Q ad decreases (Keynes effect) 3. exchange rate effect- (exchange rate depreciates) foreigners, P level increases, all else equal, our goods are relatively more expensive than foreign goods, X us decreases, Q ad

government budget deficits and surpluses policy effects

-budget deficit lowers national saving; supply of loanable funds decreases, supply shifts to the left; interest rate rises and investment falls)- crowds out private borrowers -budget surplus increases supply of loanable funds, reduces the interest rate, stimulates investment; greater capital accumulation and more rapid economic growth

closer look fiscal policy of federal gov't- budget deficit

-gov't spending, taxes, transfer programs -budget deficit: T < G; government borrows the money (selling gov't bonds), SS shifts to the left, real interest rate increases- borrow ess, investment decreases (expenditures by firms); economy shrinks- gov't crowds out firms expenditures and investments (war, worth gov't taking on) CS decreases (firms are consumers, buyers of loans PS unclear (savers= households and governments); if S shifts, PS unclear -price received increases, MC increases

Federal Funds Rate

-increase FFR by decrease money supply which pushes interest rates higher- lowers market equilibrium level of supply and demand of money interest rate that banks charge each other for overnight loans -"the veins of the economy... fastest interest rate to adjust" -Fed "targets" this rate (ex.: Fed buys bonds- injects reserves, fall in demand for borrowing reserves decreases FFR) - not discount (which is set by Fed), market is between banks -decrease in target for FFR= expansion of money supply and vice versa

adjustment of interest rate

-interest rate lower than equilibrium; Q supplied less than demanded= shortage- raise interest rate; higher interest rate encourages saving, discourage borrowing (and conversely)

Market for Money

-money supply and demand price level v. Quantity of money; -money supply is perfectly inelastic and the Fed can shift this -money demand (desire to hold dollars) cross sectional line -all else equal -surplus is below equilibrium, shortage is above

The Price Level and Investment: The Interest-Rate Effect

price level falls, households try to convert some of their money into interest-bearing assets, drive down interest rates -lower interest rates make borrowing less expensive, encourages firms and households to borrow more to invest -increase in quantity of goods and services demanded

inflation tax

printing money causes inflation, which is like a tax on everyone who holds money

aggregate supply curve

quantity of goods and services that firms produce and sell at each price level

liabilities

requirements to pay money in the future; a loan is a liability for the person who takes out a loan, but an asset to the person who loaned money out. -deposits are a liability to a bank

interest rate market for loanable funds

return to saving, cost to borrowing -price of a loan; amount borrowers pay for loans and amount that lenders receive on their saving -high interest rate makes borrowing more expensive- quantity of loanable funds demanded falls as interest rates rise-- D slopes downward, supply upward

saving incentive effects on market

saving is long-term determinant of nation's productivity -tax on interest income substantially reduces future payoff from current saving and reduces incentive for people to save -tax incentives for investment shift saving to right (increase supply of loanable funds); lower interest rates and greater investment

asset

some item of value that is expected to provide the holder some future benefit; factories are an asset because they can be used to produce goods that provide income to a firm in the future, and a bond is an asset to a bondholder because it will provide income in the future. -loans can be assets; store of value for banks because it will be paid back

Pigou effect

suggests that as prices fall and real money balances rise, consumers should feel wealthier and spend more -tax certain markets more efficiently (always excess taxes)

medium of exchange

the ability for something be used to purchase something else, such as "I can use this $5 bill to buy a grilled cheese and peanut butter sandwich"

store of value

the ability to delay using money as a medium of exchange until later, such as "I am going to keep this \$5$5 bill in my wallet so I can buy a grilled cheese and peanut butter sandwich tomorrow"

unit of account

the ability to represent the value of an item, such as "this grilled cheese and peanut butter sandwich costs \$5$5"

money multiplier

the amount of money the banking system generates with each dollar of reserves -if $100 of reserves generates $1,000 of money, the money multiplier is 10 -reciprocal of the reserve ratio (1/R) (R= required reserve ratio (rrr)) -the higher the reserve ratio, the less of each deposit banks loan out, smaller the money multiplier more complicated equation= 1+cr/ (cr+ rrr+ err) cr= currency, rrr= required reserve ratio, errr= excess reserves deposits (R/D)

aggregate demand

the demand for RGDP (production in U.S.) C+I+G+X (no imports) - shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level 4 buyers: 1. households willing to pay for NEW things 2.firms 3. government (assumed to be autonomous-gov't does its own thing) 4. foreigners

Liquidity

the ease with which an asset can be converted into the economy's medium of exchange -money is the most liquid asset available

Fisher effect

the idea that an increase in expected inflation drives up the nominal interest rate, which leaves the expected real interest rate unchanged

nominal interest rate

the interest rate that you earn (or pay) on a loan; this is the amount you see on a sign advertising interest rates.

market for loanable funds

the market in which those who want to save supply funds and those who want to borrow to invest demand funds

discount rate

the name given to the interest rate that the Federal Reserve sets on loans that the Fed makes to banks; changing the discount rate is a tool of monetary policy, but it is not the primary tool that central banks use. -increasing this leads to all interest rates rising, reduces money supply, slows lending, slows economic growth ; contractionary money supply

real interest rate

the nominal interest rate adjusted for inflation; this is the effective interest rate that you earn (or pay). -real interest rates can be negative but nominal ir can not

open market operations

the purchase and sale of U.S. government bonds by the Fed -if FOMC decides to increase money supply, Fed creates dollars and uses them to buy government bonds from the public in the nations' bond markets; dollars are then in the hand of the public -decrease money supply- sells government bonds to public in the nation's bonds market; out of hands of public

Quantity Theory of money

the quantity of money (C+D or B*mu) affects the price level and the growth of money affects inflation N= R + pi^ e R= S + D for loans (SS/ID); pi^e= growth rate money supply (true in long-run)

money stock

the quantity of money circulating in the economy

Real and Nominal Interest Rates

the real interest rate is what the lender is actually earning even after the inflation. The nominal interest rate is what the lender will charge according to inflation -real interest rate more accurately reflects real return to saving and real cost of borrowing -- always talk about real interest rate for market of loanable funds model

bank capital

the resources a bank's owners have put into the institution

Keynes effect

the stimulus to output that occurs when a lower price level raises the real money supply and thus decreases the real interest rate AD decreases, interest rate effect; biggest reason for SRAS slope

2 kinds of money

commodity money and fiat money -trick question: credit cards are NOT money (loans), debit cards are money)

currency

dollars and coins in hands of public

costs of inflation

1. a fall in purchasing power (SR- this can be true, LR- fall in pp is false) 2. shoe-leather costs (people waste resources to hold less money, wasted time to get out of checking and currency) 3. menu costs (cost to change the prices increases) 4. misallocation of resources b/c of relative price variation (some producers mistake inflation for increased demand for their goods, wasted time buyers spend to find old prices, "true" prices get distorted- inefficiency, corvette prices change more quickly than toothbrush) 5. inflation- induced tax distortions (gov't taxes nominal, not real values of banks, your interest income and dividends and capital gains are nominal and taxed)-- see notes 6. a special cost of unexpected inflation (unexpectedly go into hyperinflation)- a $10,000 loan is unexpectedly lower (better for borrowers, worse for lenders) (real value of debt increases in Depression with deflation) -all else equal, inflation increases, RA4 decreases, saving decreases, investment decreases, inflation increases, RA4 tax less than 0; ppl don't want to save anything, ppl spending

shifters of SRAS

1. anything that shifts LRAS does same to SRAS 2. nominal input prices (ex.: P oil- OPEC decreased supply of oil exporting to US, P oil increases, SRAS decreases, P level increases, y decreases *stagflation

saving supply shifters

1. government taxes interest on income decreases; save more (SS inc.) 2. introduction of tax-deferred savings (retirement plans- 401k or 403b), SS inc. 3. less consumer/student debt, SS inc. 4. higher consumer income, SS increases

investment demand shifters

1. investment tax credit (you get to write off more of your taxes, firms want to pay more money to borrowers because you are being rewarded to do something); ID increases 2. decrease in operating and maintenance cost, all projects now more profitable, ID increases (ex.: P oil falls, min wage decreases, tech advances (fracking)) 3. corporate tax rate decreases, ID increases (ex.: Trump dec. corp. taxes by 20%, shift to right; PS (savers) better off, CS (borrowers) unclear b/c demand shift; real interest rate increases, saving and investment increase)

three key facts about economic fluctuations (short run)- business cycle

1. most of them move cyclically or counter-cyclically 2. business cycles are irregular and difficult to predict 3. when output (RGDP) decreases, unemployment increases (firms lay off workers, don't need to produce as much)

4 tools to change money supply

1. open market operations (primary tool) A. open market purchase- Fed buys gov't bonds ($s in economy, increase MS) B. open market sale- Fed sells gov't bonds ($s leave economy, Ms decreases) 2. required reserve ratio= % of deposits bank must hold as reserves A. rrr inc., banks lend less, Ms decreases, B. rrr dec., banks lend more, Ms increases 3. discount rate- interest rate the Fed charges banks to borrow $, A. dr inc., banks borrow less, Ms dec.; B. dr decreases, banks borrow more, Ms inc. 4. Fed paying interest on reserves (required and excess) A. inc. interest rate on reserves, banks hold more reserves, less lending, Ms dec. B. if interest on rr and er decreases, Ms increases ASIDE: Fed now controls Base and mu (mu is direct control)

why aggregate supply curve slopes upward in short run

1. sticky wage theory 2. sticky price theory 3. misperceptions theory -the quantity of output supplied deviates from its long-run level when the actual price level in the economy deviates from the price level that people expected to prevail

with monetary policy, the Fed can...

1. target low, predictable inflation (expectations pretty consistent) 2. cause inflation to rise to stimulate economy or decrease inflation to slow down economy (Gerome Powell) -Philips curve only works in the short run , long term it is neutral -say Fed increases interest rate it pays on reserves- Ms dec, Ss decreases, N increases and R increases N (national interest rates- observable) = R+ pi (assume constant inflation in short-run) + p^d

3 sources of gov't funding

1. taxes 2. borrowing (sells gov't bonds) 3. print money- inflation tax (can lead to hyperinflation, a tax on people who hold money

elements necessary to explain equilibrium price level and inflation rate (quantity equation)

1. velocity of money is relatively stable over time 2. because velocity is stable, when the central bank changes the quantity of money, it causes proportionate changes in the nominal value of output (P*Y) 3. the economy's output of goods and services (y) is primarily determined by factor supplies (labor, physical and human capital, natural resources), and the available production of technology; money does not affect output 4. with output (y) determined by factor supplies and technology, when the central bank alters the money supply (M) and induces proportional changes in the nominal value of output (P*Y), these changes are reflected in changes in the price level (P) 5. therefore when the central bank increases the money supply rapidly, the result is a high rate of inflation

shifters of aggregate demand

1. y= C+ I + G + X; an increase in any of these leads to increase in aggregate demand -ex.: government purchases- greater quantity of goods and services demanded at any price level, AD shifts to the right 2. MV= PY; increase in M or V leads to increase in AD

other shifters of AD

1.. expectations ("animal spirits"): A. people expect income in the future, C today rises, AD inc.; B. firms expect profit in future, investment today increases, aggregate demand increases 2. fiscal policy (Fed. govt, taxes, transfer payments) A. income tax rises, C decreases, AD dec. B. gov't corporate tax decreases, I inc., AD inc. C. G increases on military, AD increases D. any form of transfer payment (ex.: welfare food stamp); AD increases E. tariffs on foreign goods increases, AD increases (ppl substitute foreign goods for domestic) 3. monetary policy (changes in money supply A. Fed can: i. open market purchase, MS inc., AD increases ii. discount rate dec., Ms inc., AD increases iii. rrr inc., Ms decreases, AD decreases iv. Fed pays interest on reserves increases, MS dec., AD dec. B. ppl held more currency, MS decreases, AD decreases C. excess reserves inc., MS decreases, AD decreases C. excess reserves inc., Ms dec., AD dec. 4. world economy A. foreign income increases, US exports inc., AD inc. B. P level foreign increases, our goods are relatively cheaper, X us inc., AD inc.

the value of money measured in terms of goods and services

1/P P= price of goods and services measured in terms of money

shifters of money supply

A. Federal Reserve (monetary policy) 1. open market operations 2. required reserve ratio 3. discount rate 4. interest rate on reserves B. economic factors 1. people can withdraw money from banks 2. banks can hold more excess reserves

shifters of money demand

A. when ATMS and credit cards came out, MD dec. B. y (Real GDP) increases, MD increases C. expected inflation (pi) increases, MD decreases; if you think dollars useless tomorrow from hyperinflation, get rid of them today; Real interest rate inc., Md decreases; you want to save more not carry more D. foreigners desire to hold fewer USD, Md decreases ex.: change in price level in bitcoins almost all due to Money demand changes, supply does not change quickly

price level and consumption- the wealth effect

Decrease in price level Increase in the real value of money (ex. can buy 2 candy bars instead of one) Consumers are wealthier Increase in consumer spending Increase in quantity demanded of goods and services

money supply equation

M= B* mu B: monetary base mu: money multiplier= 1/rrr -assumes that 1. banks hold no excess reserves (lend all they can) 2. ppl deposit all the currency they can (currency converges to 0)

all else equal, if the real interest rate increases

Md decreases

quantity equation of money

Ms x V = P x Y V (velocity of money)= NGDP/Ms; NGDP= Plevel* RGDP -if LR, money is neutral, if Fed double money supply, it only affects nominal; not true in short run (not neutral in short run) -velocity of money= the rate at which money changes hands P= price level (GDP deflator), y= quantity of output (real GDP), M= quantity of money

misperceptions theory

P level increases, some firms mistake this as D for goods increasing, rather than inflation, y increases

sticky price theory

P level increases, some prices are sticky (fixed) b/c of menu costs, restaurant prices are now relatively lower, you sell more, aggregate quantity supplied increases

supply of loanable funds

Savings from people; household buys a bond from a firm or household makes deposit in bank

stock

a slice of ownership in a company; if you own one share of a company that has a total of 100 shares, you own 1/100^\text{th}1/100 th of that company. Stocks derive their value from their ability to appreciate and the payment of dividends.

sticky wage theory

all else equal, if the P level increases, then some labor contracts that are fixed (nominal wage does not change, P level increases, real wage decreases, real cost of labor decreases); aggregate quantity supplied increases, E increases, U decreases

loanable funds

all income that people have chosen to save and lend out, rather than use for their own consumption, and to the amount that investors have chosen to borrow to fund new investment projects

central bank

an institution designed to oversee the banking system and regulate the quantity of money in the economy

demand deposits

balances in bank accounts that depositors can access on demand by writing a check

fractional reserve banking system

banks must hold a percentage of deposits as reserves (10%), and banks can lend out rest -reserve ratio= fraction of total deposits that a bank holds as reserves; influenced by both government regulation and bank policy -asset= liabilities -when banks hold only a fraction of deposits in reserve, banking system creates money (Money supply increases)

bonds

bonds are a form of an IOUs (a promise to pay back some amount in the future); bonds have three key features: the bond's par, the bond's maturity, and the bond's coupon payments. -companies and governments can get cash today in exchange for money in the future -When interest rates go up, the price of previously issued bonds goes down

Federal Reserve (Fed)

central bank of U.S. (Chair= Jerome Powell) 1. monitors the health of the banking system 2. lender of last resort (bails out) 3. conducts monetary policy (Federal Open Market Committee- FOMC)(Phillips curve- if increase money supply, inflation but lower unemployment; lower money supply leads prices fall, firms lay off workers)

classical dichotomy

changes in money supply affects nominal, not real variables; true in long-run, not true in short run -nominal (includes inflation): prices (observable), NGDP, nominal wages, nominal interest rates (dollar value) -real (exclude inflation): relative prices, RGDP (output/production), real wages (how much stuff you can buy), real interest rates, employment/unemployment