ECON: Test 2

Marginal propensity to consume (MPC):

The portion of additional income that is spent on consumption. Savings detract from GDP in the short run so you want to see whose going to spend and whose going to save (Keynesians look at MPC to decide on what groups in the economy to target with stimulus) MPC = change in Consumption/Change in income 0 < MPC < 1; MPC is not constant among everyone

Examples with article about COVID

The results suggest that labor supply socks accounted for most of the fall in hours in March and April. However there were more significant demand shocks in sectors that should not be very directly affected by the lockdown, such as manufacturing Initially supply was the bigger culprit Industries hit the hardest: hospitality, food and beverage, transportation, all the things we do socially with other people (high contact areas) Industries not negatively impacted: ecommerce, IT (Zoom)

How does fiscal policy work?

The use of government spending and taxes influence the economy Taxes and spending changes must be legislated and approved by congress and the president. Politicians have to vote on it and then the pres has to sign on it Can be used in conjunction with (or instead of) monetary policy to steer the economy. Fiscal policy is political however monetary policy is supposed to be separate from politics

Domestic Factors that SHIFT Aggregate Demand

Anything that changes major spending habits of individuals and firms will shift AD. This includes change in real wealth, expected income, and expected price levels

net worth

Assets - Liabilities

Discount Loans

Banks don't like to take out discount loans because they're publicly traded companies and there is a stigma about taking them out, therefore banks are slow to respond to potential crises.

Great Recession (2008-2009)

housing prices increased creating a bubble in home prices, making wealth increase tremendously because the majority of people's wealth resides in their home ownership. This created a tremendous increase in aggregate demand (investment/consumption). Then negative things started coming out about housing, making people sell, making home prices crash, destroying wealth. And because stock prices were doing well at the time as well because general wealth was so high, stock prices crashed as well.

Spending Multiplier:

illustrates the total impact on spending from an initial change of a given amount; m = 1/(1-MPC) Change in GDP = (1/(1-MPC)) * change in consumption

Menu costs

Costs associated with changing prices, can cause output prices to be sticky. If the general price level falls, but firms do not adjust their output price (due to menu costs), the quantity demanded of their product falls which means lower output This happens systematically throughout the economy, and aggregate output falls Ex. Restaurant (high menu costs) can be expensive to reprint menus for all establishments

central banking

"the lender of last resort", now banks could borrow from the Fed if they need to. A "bank for banks". Offers support and stability for banking system via discount loans ( the fed makes a loan to a bank, which then the bank has to pay back with interest and the rate is called a discount rate)

Keynsian Economics

- Adjustment will be long and occur unpredictably with many delays - More inclined to call for government interventions in the market - Believe that many prices are sticky - Do not like savings because it hurts short run performance (focus on policies that'll increase aggregate demand through government policy with stimulus plans)

Article about the meeting

- Participants thought that real GDP would slow in the near term - Participates noted that generally inflation was slowing - Majority though it was critical that the stance of monetary policy be kept restrictive to return inflation to the Committee's 2% objective - Assessed that real GDP had been expanding at a solid pace and had been more resilient than expected... nevertheless, growth would slow in the short term - Current stance of monetary policy was restrictive and that it... appeared to be restraining from the economy as intended - Further evidence would be required... to be confident that inflation was clearly on the path to... 2 percent objective - Some softening in labor market conditions as likely to be needed to bring aggregate demand and aggregate supply into better balance and reduce inflation pressures - In discussing the policy outlook, participants continued to judge that it was critical that the stance of monetary policy be kept sufficiently restrictive to return infla

How do Federal Governments Raise Revenue

- Payroll taxes (deducted from paychecks): income tax, social security, medicare - Other tax revenue sources: corporate taxes, estate and gift taxes, excise taxes (on things like gas), and custom taxes (taxes on imports)

Classical Economists

- The economy's adjustment toward long-run equilibrium will happen naturally - General policy is to let the economy go and the market will correct itself - Prices can adjust - Think savings are crucial for long run economic growth (focus on LRAS)

International Factors that SHIFT Aggregate Demand

- foreign income and wealth (If foreign nations become wealthier, demand for US goods increase (NX increases) If a foreign nation goes into a recession, demand for US goods decreases (NX decreases)) - exchange rate: (If the value of the dollar rises. US can buy more imports, but other countries can buy less US goods (decreasing exports), so NX falls, leading to a left shift in AD Similarly, the value of the dollar could fall, leading to an increase in NX If the exchange rate has fallen, the american good is cheaper, means increase in AD via more export sales)

Domestic Factors that SHIFT Aggregate Demand (broken down)

- stock market rises or falls (if it's rising, wealth in the overall economy is rising, so people increase their AD for goods and services - widespread change in real estate values (as home prices increase, wealth increases, so AD increases) - general expectations about the future (higher or lower income in the future) - changes in consumer confidence

Functions of Money

1. Medium of exchange (use money as a means of trade) 2. A unit of account: we can price things with money and understand what it costs. 3. A store of value: money has value, but it is a poor store of value because of inflation which is constantly eroding the value of money (the purchasing power)

Shifts in Long Run AS

1. Resources (ex. oil, natural resources) 2. Institutions (ADD) 3. Technology (AI, improves efficiency) Ex. technology shock: improves output, lower price level because efficiency is higher, same unemployment because same number of workers they are just more efficient. There is a strong incentive to make scalable technological improvements because it can produce more money

Government Policy Response to Great Depression

1. in 1928 and 1929, the government reduced the money supply in hopes of controlling stock prices, which policymakers thought were too high. The lower money supply brought on a panic among people --> 2. This policy error involved banks all over the country as financial panic spread, 9000 banks failed from 1930-1933 3. Government had the ability to lend to these banks but it didn't. Thus the money supply decreased even further 1929-1933: money supply decreased by one-third 4. Hoover and Roosevelt raised taxes in attempts to balance budget which further reduced AD 5. Smoot-Hawley Tariff Act: Imposed tariffs on thousands of imported goods. Set off a "trade war", and other countries taxes US exports, which decreased global demand for our products

Great Depression

2 separate recessions (1929-1933 and 1937-1938) - prices across the economy fell throughout the decade. At the end of the 1930s, the price level was still 20% lower than 1929. after Black Thursday, AD decreased due to people's lower expected future income. 1929-1932: stock prices fell by almost 90% - The decline in prices indicates that the primary cause of the Great Depression was a decrease in AD. - Stock prices were up a lot in the 20s and banks were not prohibited in investing saver's money in the stock market and it worked out while it worked, allowing the banks to make a lot of money. In 1929, the fed started raising interest rates because they were worried about the market overheating and the stock market crashed. 9000 banks went out of business. - Drop in the stock market can shift aggregate demand because it decreases wealth. There was also a big drop in GDP, creating a massive increase in unemployment (25%) During this decade there was prolonged deflation (falling in the price level)

Phillips Curve

A short term downward sloping phillips curve - a tradeoff between inflation and unemployment. Bringing inflation downs means you will have higher unemployment.

The 2 factors that affected AD during the Great Recession

Decrease in wealth: real estate is often the single largest portion of an individual's wealth. Stocks lost one third of their value in 2008. Decrease in expected income: people realized things were getting bad. Consumer spending decreases during time of uncertainty decreasing aggregate demand further

Business of Banking

Deposits (primary source of funds) → BANK → Loans (primary use of funds) Banks cannot invest in stocks. They can lend money to consumers or invest in bonds (usually government bonds because they're safe)

Why Monetary policy doesn't always work

Diminished effects in the long run You form expectations, reducing the effects of policy Policy is limited if downturns are caused by AS shifts rather than AD shifts

recent fiscal policy

Economic stimulus act 2008: tax rebates. Goal (which was unachieved): hope that this money is spent, stimulating the economy American Recovery and Reinvestment Act, 2009. Focused on government spending. goal of increasing aggregate demand.

Expansionary Fiscal Policy (2 ways to do it)

Government increases spending or decreases taxes to stimulate or expand the economy. Shift GDP to the right (increase in AD) so that unemployment falls and GDP increases Increase government spending (G). If private spending (C, I, and NX) is low, then government can increase AD by increasing G Decrease taxes (T). reducing the overall tax burden on private individuals, and gives them more to spend, increasing C Tax rebate: given a debit card, can't save any of it, it has to be used to buy things During covid: both a tax rebate and trillions of dollars spent in government spending led to a quick recovery

Federal Deposit Insurance Corporation (FDIC)

Government program that insures your bank deposit. It is a massive financial lifeguard so even if a bank goes bankrupt, you get your deposits back. Goal: increase bank stability, decrease bank runs (then the bank can participate in more risk taking, because customers are not as worried)

Article about wages and hours

If hours (quantity) and wages (prices) move in the same direction we assign more probability to those movements being caused by a demand shock. If hours and wages move in opposite directions, we assign a higher probability to a supply shock. Supply curve shifting to the left, wages (prices) go up but hours (quantity) falls

Measuring the money supply (M2)

Includes M1 (post covid) and CDs

increase minimum retirement age (pro/con)

People are living longer, so they could work longer. Cost of doing this is if someone planned on retiring at 65, you are delaying their long term plans

Measuring the money supply (M1)

Pre covid: currency, checking deposits, and travelers checks Post covid: currency, checking deposits, travelers checks, savings accounts and money market account

higher payroll tax (pro/cons)

Pro: This would mean more money paid into the social security trust fund so that it runs out later Con: The cost of raising payroll tax means less disposable income available to the worker

2008 quantitative easing

QE 1: targeted bond purchases QE 2: long term treasury bond purchases QE 3: purchases of mortgage backed securities

Supply Side fiscal policy

R&D tax credits Policies that focus on education Lower corporate profit tax rates Lower marginal income tax rates

Money multiplier

Rate at which banks multiply money when all currency is deposited into banks and they hold no excess reserves. m^m = (1/rr)

required reserves: excess reserves:

Required reserves = rr (required reserves rate) x deposits Excess reserves = total reserves - required reserves

sticky input prices

Resource prices tend to be sticky, set by contracts. Ex. fixed interest rates, yearly wage contracts, coffee beans contract, leases Output prices: more flexible, easier to change (ex. Price of the final coffee) Short run result if output prices (price level) rise, while sticky prices remain constant that means that profit goes up, so it's more profitable to produce the good, so SRAS goes up Profit = total revenue (price x quantity; output price) - total cost (inputs)

multipliers (fiscal)

Spending by one person becomes income to others; true for private and government spending Increases in income generally lead to increases in C

bank regulation

The Fed monitors and evaluates what banks are doing quarterly. (ex. Silicon valley bank) They set and monitor reserve requirements to limit risk. Monitors private banks, but not other private firms because due to the interconnectivity of assets, bank problems can quickly spread to the entire industry.

Laffer Curve

There is a t* that exists that maximizes tax revenue Region II: increase tax rates to the right of the optimal tax rate, tax revenue will actually decrease. If you decrease taxes in region II then tax revenue would increase Region I: if you increase tax rates, it would increase revenue. If you decrease tax rates it would decrease revenue.

Expansionary open market operation (quantitative easing)

This is a targeted use of open market operations where the central bank buys securities specifically targeted in certain markets Ex. Targeted in the housing market - special bonds, long term bonds, mortgage backed securities it amounts to the Fed printing trillions of new dollars and putting them in targeted sectors. This increases the demand for bonds, increasing prices for bonds, and decreasing interest rates

Open Market sale

This is contractionary policy. Fed exchanges bonds for existing dollars Use when there is an overheating economy (when Y > Y*) creating inflation (inflation > target of 2%) - trying to decrease AD. increases interest rates.

Open Market Purchase

This is expansionary. Fed buys bonds with new dollars recession/slowing economy, deflation → trying to increase AD by increasing Y = G + I + C + NX, by having the Fed enter financial markets to buy bonds from banks. This decreases interest rates so firms are more likely to invest, causing I to increase

Why doesn't fiscal policy work perfectly?

Time lags: it takes time to put the policy out there Crowding out: assuming we're in a budget deficit, so borrowing money in a budget deficit increases the demand for loanable funds, and interest rates will increase, causing consumption and investment to fall Saving adjustments: consumers consumption smooth so if consumers expect more taxes in the future they will save more now, reducing the effect of government spending

Aggregate Demand

Total demand for final goods and services in the economy Sources: foreign economies, consumers, businesses (have to buy things for their business), government. Equation for AD = C + I + G + NX (GDP)

Aggregate Supply

Total supply of final good and services in the economy Sources: Mostly private businesses and the government

Shifts in Short Run Aggregate Supply in Relation to LRAS:

Whenever the long run AS curve shifts, it takes the short run AS with it However there are 3 factors that shift only the short run AS curve 1. Temporary supply shock (production of oil, problems in other countries) shifting SRAS to the left (price level increase, quantity decreases) 2. Changes in expected future prices 3. Adjustments to errors in past price expectations With an unexpected decline in SRAS there is an increase in unemployment such that unemployment > the natural rate (u*)

Long Run AS curve

Y=Y* (GDP = real GDP where unemployment equals the natural rate of unemployment, regardless of the price level

interest rate effect

a change in the price level indirectly leads to a change in the interest rate. As people save less (wealth effect: you are still buying the same things forcing you to save less because prices are higher) it reduces the contribution to AD. If savings decrease, there is a higher interest rate (LFM), so a lower quantity in AD

Interest on Reserves (IOR) at Fed

a monetary policy tool used by the Federal Reserve to influence the banking system and implement their monetary policy objectives. It involves paying interest on the reserves that banks hold with the central bank, typically the reserves they are required to maintain. For example if they raise IOR banks will be more likely to have more excess reserves, lending less money out, reducing I, reducing AD

Central Banking (federal funds)

banks keep reserves at the Fed so the Fed can clear loans between banks. Often very short-term loans. Borrowed at the federal funds rate (the interest rate on loans between private banks) → if the fed funds rate goes up they also change the interest rate on reserves to keep the money at the Fed.

Cost of holding reserves

before 2008, reserves earned no interest. Now any reserves held at the Fed earn interest. After 2008, banks started reserving trillions of dollars because of inflation

Bank Balance sheet (liabilities)

checking deposits

Lower marginal income tax rates

create incentives for individuals to work harder and produce more, since they get to keep a larger share of their income

Bank Reserves

each bank has to have a certain amount of required reserves at the Fed.

The Federal Reserve and their 3 responsibilities

established in 1913 as central bank of the US 1. monetary policy 2. central banking 3. bank regulation

means testing

everyone qualifies for social security right now, this would make it so that not everyone qualifies based on income. This could save some money but one big push back is that not all of your salary has the social security tax. Ex. very wealthy people making hundreds of billions of dollars a year can only pay up to 160,000 per paycheck, so they're not even paying in that much compared to the total of their paycheck

Expansionary monetary policy in the longrun

expansionary policy (AD1 → AD2) leads to increase in Y, a decrease in unemployment, and an increase in price level, however people have expectations (they know that with expansionary policy will increase the price level), so they argue a higher wage (creating consumption smoothing), increasing the cost for businesses, so business start supplying less, decreasing SRAS. So in the long run we end up with a higher price level, GDP levels out and so does unemployment. [this idea is called monetary neutrality - that in the long run monetary policy is ineffective]

income taxes

first started in 1913, increased dramatically during the Great Depression (they thought outlays had to equal revenue) because there were so many people unemployed so they had to take more out of the paychecks of those that were still working

R&D tax credits

gives firms an incentive to spend resources on technological advancement. Government gives firms a tax credit which will give them more money to maybe find something more productive to shift out supply

Social security:

government administered retirement program. Requires workers to contribute a portion of their earnings to the Social Security Trust Fund Goal: guarantee hat no american worker retires without at least some retirement income

Contractionary fiscal policy

government decreases spending or increases taxes to attempt to slow the economy. Decrease AD (shift to the left), GDP goes down, unemployment goes up and inflation goes down. Would only do this to get inflation down, they don't actually want GDP to decrease and unemployment to increase Want to slow the economy to either pay off government debt or to keep the economy from expanding beyond long run capabilities.

Bank Balance sheet (assets)

government securities: government bonds required and excess reserves loans: primary interest-earning use of bank funds

government outlays

government spending + transfer payments

how to fix social security problems (running out of money)

higher payroll tax, increase minumum retirement age, means testing, Invest social security trust fund in higher return assets

Short Run Aggregate Supply

higher price level, higher production of goods of services, so higher real GDP Short run: time period in which not all prices have adjusted to some macroeconomic change. Some prices adjust immediately, others don't.

monetary policy

inflation problems, growth problems, unemployment problems, financial risk. Anything that can impact the macroeconomy. Policies to move AD (stimulate when it's bad, slow it when it's too strong so inflation can go down)

Price Level and AD

lower price level --> a higher real GDO higher price level --> lower real GP downward sloping curve

Money Illusion

occurs when people irrationally interpret nominal values as real values. Workers are very reluctant to accept pay decreases, even if the pay decrease is nominal. This reinforces input price stickiness. Firms will reduce output in response to decreases in the price level, rather than cut wages.

transfer payments (which are mandatory/which are discretionary)

payments made to individuals when no good or service is received in return, income assistance (welfare), social security Mandatory: social security, medicare (likely to grow more as boomers get older), income aid, ect Discretionary: defense, misc. discretionary

lower corporate profit tax rates

provides increased incentives for corporations to undertake activities that add more profit. this may stimulate R&D

Invest social security trust fund in higher return assets

put a small percent of the fund in to make a greater return. Con: it could get political because who gets to decide what industries to invest in

3 reasons why AS is upward sloping (slides along SRAS)

sticky input prices, menu costs, money illusion

Policies that focus on education:

subsidies or tax breaks for education (Ex. Pell Grants) create incentives to invest in education, increasing effective labor resources. If we increase the knowledge of our labor force, that could increase productivity, shifting AS

wealth effect

the change in purchasing power of money when the price level changes. a higher price level reduces the purchasing power of wealth, so GDP is lower because you can't buy as much with your wealth

Monetary neutrality

the idea that money supply does not affect real economy variables.

Quantitative Tightening

this is contractionary MP which is another tool to raise interest rates the fed will redeem treasury bonds up to this monthly cap of $60 billion and treasury bills to the extent that coupon principal payments are less than the monthly cap. When bonds expiring cost less than 60 billion they will let them expire and not buy new bonds Reinvest into agency MBS (mortgage backed securities) received in each calendar month that exceeds a cap of 35 billion per month. They redeem MBS less than 35 billion At maturity you have to pay the principal payments. What the fed can do is take the amount paid at maturity to buy new bonds. If they're letting bonds expire and not replacing them, demand decreases for bonds, and prices fall for them meaning interest rates go higher

national debt

total of all accumulated and unpaid deficits. All of the unpaid bonds that they've sold and are outstanding that were used to finance the budget deficit

3 reasons why AD is downward sloping (slides along AD)

wealth effect, interest rate effect, international trade effect

Quantitative Easing

when the Fed buys bonds (this increases demand for bonds, so bond prices go up, and interest rates go down)

budget deficit

when the tax revenue is less than all the different outlays. a shortfall in revenue for a particular year's budget. The difference between government outlays and tax revenues: tax revenues - government outlays Without deficits we would have no need for government bonds.

international trade effect

with a higher price level for american goods, the goods are more expensive for both american and international consumers. So, a change in the domestic price level leads to an inverse change in the quantity demanded for domestic goods (ex. if price level goes up, less domestic goods bought). Instead people will buy more foreign goods --> Net exports will become a bigger trade deficit, decreasing AD Also foreigners will consume less american exports, reducing our exports.