Macro exam 3

Suppose you take $100 out of your pocket and put it in your checking account. If the required reserve ratio is 20%, what is the maximum amount of money created from this deposit?

$500

Explain why fiscal policy does not always shift the AD curve by the exact right amount to reach a new long-run equilibrium.

-Potential output must be correctly estimated -able to calculate the spending multiplier correctly

If real GDP increases by 3% and the money supply increases by 2%, what does the quantity theory of money predict the inflation rate will be?

2% - 3% = -1%

In what situations would contractionary fiscal policy be recommended? How might you implement this type of policy? Why would you implement this policy --- what are the reasons why it might make sense to slow the economy through government policy?

A contractionary fiscal policy would be used when the economy is experiencing an expansionary gap. An indication of this would be high inflation. Government spending could be decreased and/or taxes could be increased. This could be to try to fight inflation, or simply to smooth the business cycle so that the next recession will not be as severe.

When does government debt become a problem for a country?

A country must at least pay the interest on it's debt, this takes away from other government programs. If the government can't spend money on education or public capital accumulation, growth could suffer in the long-run. A country must also be able to continue to borrow, so if a country cannot continue to sell debt, it will have to raise taxes or cut spending.

What is the difference between a deficit and government debt?

A deficit is occurs when tax collections are less than government spending during a particular year, whereas government debt is the accumulation of deficits over time.

The US estimates that there is $1.1 trillion in currency outstanding. Give 2 reasons why this number is so high.

A lot of our money is held abroad; some countries even use the US dollar as their official currency.

List the properties of ideal money.

Acceptable to most people Standardized quality Durable Portable Divisible - for large and small purchases Low opportunity cost

What are automatic stabilizers? Give some examples of automatic stabilizers during a recession.

Automatic stabilizers are a form of fiscal policy that do not require the passage of a new law. For example, during a recession, tax collections decrease since people are making less money and government spending on programs such as unemployment insurance, food stamps, and other welfare programs increases because more people become eligible for them.

Explain how money improves upon the barter system

Barter can be time consuming since it can take several trades to arrive at a double coincidence of wants. If everyone is willing to accept money, there will always be a double coincidence of wants

. Explain some of the limits on fiscal policy's effectiveness

Consumers base their spending on their permanent income, so temporary decreases in taxes, or even tax cuts that are perceived to be temporary will not increase consumer spending by as much as permanent tax cuts.

Show how an economy currently experiencing an expansionary gap can move to a new long-run equilibrium using fiscal policy. Would this be an expansionary or contractionary fiscal policy?

Contractionary AD: shifts left Price level: decreases RGDP: decreases

How are crowding out and the multiplier effect similar and different?

Crowding out and the multiplier effect both affect the aggregate demand curve. The multiplier effect shifts AD further to the right after an increase in AD, whereas crowding out decrease AD after its initial increase.

components of M1

Currency Checkable deposits Traveler's checks

If a government wants to implement an expansionary fiscal policy, what are the two broad options that they can choose from?

Decrease taxes and/or increase government spending

Explain 4 tools the Fed can use to increase the money supply. Be specific(for example buy or sell, increase or decrease)

Decrease the reserve ratio Decrease the interest rate paid on reserves at the fed Decrease the discount rate Buy bonds

What is a bank run? If there is a run on a bank, how will depositors get their money?

Depositors run to a bank and withdraw their money. Since banks do not hold all deposits as reserve, they might run out of money. If a bank closes as a result of a run, depositors will get their money from the FDIC

What are some shortcomings of monetary policy?

Don't know exactly how far to shift AD Might not be able to shift exactly as far as Fed wants to (Zero Lower Bound) Current economic variables are observed with a lag Monetary policy has a lot of the same shortcomings as fiscal policy, but does tend to be quicker to implement since it does not involve hiring workers or congress agreeing to pass a law.

What are the functions of the federal reserve?

Ensure the health of the banking system and control the money supply

components of M2

Everything in M1 plus Savings deposits Small denomination time deposits Money market mutual fund accounts

Show how an economy currently experiencing a recessionary gap can move to a new long-run equilibrium using fiscal policy. Would this be an expansionary or contractionary fiscal policy?

Expansionary AD: shifts right Price level: increases RGDP: increases

What is the difference between commodity money and fiat money?

Fiat money has no intrinsic value, commodity money does have it's own value as something other than money.

What is fiscal policy? How is it implemented?

Fiscal policy is the actions of the federal government that affect taxes and/or government spending. The congress passes a bill and the president signs it into law.

Why is fiscal policy poorly suited to dealing with stagflation?

Fiscal policy will either increase inflation or unemployment, making the economy even worse off than it is already in these terms. Inflation and unemployment are already high, using fiscal policy will make one of these worse, depending on if an expansionary or contractionary fiscal policy is used.

If an economy decides to use gold as money, how well does this money fulfill the properties of ideal money?

Gold would be acceptable to most people. There are ways to melt it to determine quality is standard. It is durable. It would not be very portable for big purchases since it is heavy. It would not be very divisible, you would have to melt it. Also, the opportunity cost would be high since gold could be used for other purposes, such as gold teeth and jewelry.

Rank this list of assets from least to most liquid: currency, a house, savings account deposits, stocks

House, stock, savings deposits, currency

If a government wants to implement a contractionary fiscal policy, what are the two broad options that they can choose from?

Increase taxes and/or decrease government spending

Explain what it means when we say that there is a zero lower bound on interest rates. Will buying bonds be a useful policy once an interest rate of zero is reached?

Interest rates cannot be negative. Once an interest rate of zero is reached, buying bonds will not be useful. Everyone who wants to take out a loan already has and banks won't be willing to lend at a negative rate.

During the 2007 recession, the Fed used monetary policy to reduce interest rates in the economy. Use what you have learned to give a possible explanation as to why this failed to restore the economy to a long-run equilibrium

Interest rates fell to zero. After that, traditional monetary policy cannot have any further effects. Everyone who is willing to take out a loan at close to zero percent, has already done so and interest rates can't be negative.

If real GDP increases and money supply does not change, what will happen to the price level, according to the quantity theory of money?

It will decrease

If the money supply grows faster than real GDP, what will happen to the price level, according to the quantity theory of money?

It will increase

Who is the chairman of the Fed?

Janet Yellen

When did Keynesian economics first gain popularity? What were some of the factors that caused this?

Keynesian economics gained popularity following world war II. Keynes published his work in the 1930's and a dramatic increase in government spending due to the US entering the war was credited with ending the great depression.

How do Keynesian economists differ from classical economists? What do they believe the government should do in times of recession?

Keynesian economists believe that short-run fluctuations are harmful to economies and their citizens. Classical economists believe that we should only be concerned with the long-run health of an economy. Keynesian economists would advocated for the government to use fiscal and monetary policies.

Why is money a poor way to hold wealth?

Money can be lost or stolen and there is no way to link a particular dollar to a particular person. Money also does not earn interest, so it loses value over time when there is inflation.

Can fiscal policy decrease both inflation and unemployment at the same time?

No. An expansionary fiscal policy will decrease unemployment, but increase inflation. A contractionary fiscal policy will decrease inflation and increase unemployment.

Are credit cards money? Why or why not?

No. Credit cards are used in transactions, but are not a store of value or unit of account. They are a way of deferring payment that will have to be paid off with money at a later date.

Give 2 reasons the real world multiplier is smaller than the simple deposit multiplier.

People cannot be forced to deposit all of their money in banks banks cannot be forced to lend out all of their excess reserves

What are some less controversial uses of deficit spending?

Spending on capital projects and wars are viewed as not very controversial uses of deficit spending because the benefits last for years after the expenditure has been made, so it makes sense for future generations to pay since they are also receiving the benefits.

List the 2 monetary policy goals. Does the Fed have to choose between each of these?

Stable prices and high employment. Yes, monetary policy involves a tradeoff between either increasing unemployment or inflation.

What is stagflation? Why is it so harmful to an economy? During which decade did the US experience stagflation?

Stagflation is the combination of stagnation in real GDP (falling real GDP) and inflation. This will also mean that unemployment will be higher than the natural rate. These are all harmful to an economy and its households. Inflation is more manageable when people have jobs. Stagflation is the worst of both worlds - people are unemployed and prices are increasing. The US experienced stagflation during the 1970's.

If inflation is high, which of the functions of money is violated?

Store of value

Mia puts money in her piggy bank so she can spend it later. What function of money does this illustrate?

Store of value

List the 3 functions of money

Store of value, unit of account, medium of exchange

During a recession, without any changes to the law, what happens to the amount of taxes collected? What happens to government spending? If the federal government were required to balance the budget every year, what would need to be done to taxes and/or spending during a recession? Would this make the recession more or less severe?

Tax collections will fall since people make less money. Government spending will increase as more people qualify for welfare programs. If a balanced budget was required, taxes would have to be increased and/or government spending cut. This would actually be a contractionary policy and would make a recession more severe.

What is the debt ceiling? How did congress' debt ceiling debate in 2011 affect the United State's ability to borrow money?

The debt ceiling is a cap on how much debt the country can have. The debt ceiling debate led to the US government bonds being downgraded by credit rating agencies. This could create a problem where purchasers of US government bonds would not trust that they will be paid back. So far, this has not happened.

How is the discount rate different from the federal funds rate?

The discount rate is the rate that the Fed charges banks for loans and the Fed directly sets this rate. The federal funds rate is the rate that banks charge each other for loans. The Fed does not have direct control over setting this rate, but can increase or decrease it by changing the money supply

If the Fed wants to increase the federal funds rate, how can they achieve this?

The fed will decrease the money supply by selling bonds. When banks have less money available for loans, they will charge more for loans. This would include the interest rate that banks charge each other for loans, the federal funds rate.

Would you describe the actions of the federal government during the 2008 recession as classical or Keynesian? Why?

The government implemented tax cuts and government spending increases (the stimulus), so these would be Keynesian policies.

Describe the role the required reserve ratio plays in determining how much money the banking system creates

The higher the reserve ratio is, the less a bank can lend out, so less money will be created

What was the sequester? How did it come about? What was the result?

The sequester was a series of automatic federal spending cuts that congress instituted to try to force themselves to pass a budget. If congress did not agree on a budget, the automatic cuts would kick in. This was created as a result of several years of continuing resolutions. Congress did not agree on a budget and the automatic cuts were instituted. This did help to keep spending flat for the years following the sequester

Give an example of a discretionary fiscal policy.

The stimulus bills in response to the 2008 recession are examples of discretionary policies

Could a government proceed in debt forever? Explain why or why not.

Theoretically, since a government does not die or retire and live off of savings like an individual person does, it is possible that a government could be in debt forever so long as there are people willing to lend to the government.

When a government has a budget deficit, what will happen to its trade balance?

There will also be a trade deficit - this is referred to as the twin deficits.

What do classical economists believe that the government should do in times of recession?

They would believe that the government should not get involved in the economy. They believe that the economy will correct itself.

Draw what happens to the AS/AD model when there is an expansion caused by optimism in the economy. Show how monetary policy could move the economy back to a long-run equilibrium. Explain what specific policies would be implemented. Is this expansionary or contractionary monetary policy?

This is a contractionary policy. The Fed would decrease the money supply by selling bonds, increasing the reserve ratio, increasing the interest rate paid on reserves, increasing the discount rate AD: shifts left Price level: decreases RGDP: decrease

Draw what happens to the AS/AD model when there is a recession caused by pessimism in the economy. Show how monetary policy could move the economy back to a long-run equilibrium. Explain what specific policies would be implemented. Is this expansionary or contractionary monetary policy?

This is an expansionary policy. The Fed would increase the money supply by buying bonds, decreasing the reserve ratio, decreasing the interest rate paid on reserves, decreasing the discount rate. AD: shifts right price level: increases RGDP: increase

What is the gold standard? Was this money considered commodity or fiat money? Are we still on the gold standard?

Under the gold standard, paper money could be exchanged for gold. This would be commodity money. We are no longer on the gold standard

The statement "my iphone is worth $300" represents which of the functions of money?

Unit of account

a. Draw a graph of the money market and label the axes and curves. b. If the economy is experiencing high unemployment, what 2 policies should the Fed undertake? The Fed could increase the money supply by buying bonds and decreasing the interest rate paid on reserves c. Show this shift on your graph in part a. What happens to the quantity of money and the interest rate? (above) d. We know that these effects will carry over in to the AS/AD model. Using a graph of the static model where P is the price level and rGDP is real GDP and the economy is currently at a short-run equilibrium below potential GDP, show what will happen if the Fed carries out these policies. Show the appropriate shift. What happens to the price level and real GDP?

a. MS: shifts right MD: stays put Interest rate: decreases Quantity of money: increases b. the fed could increase the money supply by buying bonds and decreasing the interest rate paid on reserves c. on graph d. AD: shifts right Price level: increases RGDP: increases

Suppose an economy has $2,000 a. If people hold all the money as currency, what is the quantity of money? b. If people put all of their money in banks and banks hold 100% of deposits as reserves, what is the quantity of money? c. If people deposit all of their money in banks and banks hold 10% of deposits as reserves, what is the quantity of money? d. If people deposit all of their money in banks and banks hold 5% of deposits as reserves, what is the quantity of money?

a. $2,000 b. $2,000 c. 20,000 d. 40,000

A bank starts with 100,000 in deposits. a. If the required reserve ratio is 20%, how much does the bank have in excess reserves? b. Calculate the simple deposit multiplier. c. How much money will be created?

a. $80,000 b. 5 c. $500,000

Suppose that taxes are decreased by $100 million and output increases by $85 million. a. What is the tax multiplier? b. Does this number indicate whether there is crowding out or a multiplier effect? c. 5 years later, the economy experiences another recession. If the multiplier is the same, by how much should taxes be cut to increase output by $200 million?

a. .85 b. crowding out c. $235 million

Suppose that taxes are decreased by $100 million and output increases by $125 million. a. What is the tax multiplier? b. Does this number indicate whether there is crowding out or a multiplier effect? c. 5 years later, the economy experiences another recession. If the multiplier is the same, by how much should taxes be cut to increase output by $200 million?

a. 1.25 b. multiplier effect c. $160 million

Assume that First Tampa Bank holds $2,000,000 in deposits, $400,000 in reserves and $1,600,000 in loans. a. draw a T account for this scenario b. what is the required reserve ratio? c. If the bank receives a new deposit of $1,000,000 and the banks wants to loan out the maximum amount allowed, how much of this new deposit will be lent out? d. add this to your T account e. What is the simple deposit multiplier? f. When this new $1,000,000 works its way through the banking system, what is the maximum amount of money that will be created?

a. Assets: $400,000 reserves Liabilities: $2,000,000 deposits Assets: $1,600,000 loans Liabilities: (d.) Assets: $200,000 reserves Liabilities: 1,000,000 deposits Assets: $800,000 loans b. 20% c. $200,000 d. add letter c. to t account above e. 5 f. $5,000,000

Classify each of the following as commodity money, fiat money or not money a. The euro b. gold coins c. cigarettes d. credit cards e. The Mexican peso f. pouches of mackerel

a. fiat b. commodity c. commodity d. not money e. fiat f. commodity

The Fed's original goal was high employment (low unemployment). What has happened to the other monetary policy goal?

there will be inflation

Is the US currently in debt? Do we currently have a budget deficit?

yes and yes