Macroeconomics Unit 3

Increase in money supply=

(1/r)* Excess reserves

Expansionary Monetary Policy

(Easy) increasing the money supply to decrease interest rates, which increases consumption, investment and net exports and therefore increases AD; used to fight unemployment/low demand

Contractionary Monetary Policy:

(Tight) decreasing the money supply to increase interest rates, which decreases consumption, investment and net exports; which decreases aggregate demand; used to fight inflation

The Goals of the Fed

*Full Employment (4-5% unemployment), Economic Growth (2.25-3% growth in real GDP), *Price Stability/Low inflation: 2-3% inflation, Exchange Rate Stability, Interest Rate Stability, Financial Markets Stability: no SIFI failures (Systematically Important Financial Institutions, sometimes said to be TBTF-Too Big to Fail)

The discount rate is the interest rate paid by...

...banks that borrow from the fed

Banks increase the money supply when they...

...make loans

Prior to 2008, the Federal Reserve moved the federal funds rate higher and lower using...

...open market operations

If there is slack in the resource market...

...production costs will decline, and AS shifts right.

AS: As the Price Level increases...

...real GDP increases

There is tightness in the resource markets if...

...real GDP is above potential GDP.

There is slack in the resource markets if...

...real GDP is below potential GDP

Sales/Excise taxes are often...

...regressive, because a higher percentage of low-income people's earnings are exposed to the tax

Whereas the federal reserve used to set a single target for the FFR, it now...

...sets a range that is 25 basis points wide

Government spending is determined by...

...the Congress and is independent of any economic variables

The chairman of the Fed is chosen from...

...the board and has a 4-year term

The Fed targets...

...the federal funds rate

In the 'ample reserves' framework of monetary policy...

...the federal reserve moves the FFR into the target range primarily by adjusting the IOER rate

If AD increases...

...the price level (inflation) and real GDP increase

If AS increases...

...the price level (inflation) decreases and real GDP increases

AD: As the price level increases...

...the total quantity of an economy's final goods and services demanded decreases

How many nonrenewable terms?

14

Board of Governors

7 members appointed by the President of the U.S. and confirmed by the Senate

Income

As domestic ___ rises, so does consumption, and some spending is for foreign goods. Imports rise and net exports would drop. If foreign ___ rises, they'd buy more of our exports, and net exports would rise.

How does arbitrage ensure that the FFR does not drop too far below the IOER rate?

Banks have an incentive to borrow at the FFR and deposit at the IOER.

Most money in the US is held in the form of...

Checking Accounts

Who is responsible for Fiscal Policy?

Congress

Discretionary fiscal policy

Congress acts at its discretion to change government spending or taxes

FOMC (Federal Open Market Committee):

Decides monetary policy

Which of the following best describes how the federal reserve might use the current framework to increase employment during a recession to achieve its maximum employment objective?

Decrease the target range for the FFR

Quantitative Easing

Differs from open market operations in that the Fed buys financial assets from financial institutions other than short term Treasury securities. The assets may be longer term or more risky.

Adjustments in the stance of monetary policy are communicated as a change in which of the following?

FFR

What is the name of the banking system where banks loan out more money than they have on deposit?

Fractional reserve system

International trade effect

Higher prices mean prices for goods and services produced in the U.S. are not competitive with foreign made goods

Interest rate

If the cost to borrow increases, businesses will spend less

Exchange Rates

If the dollar got stronger, net exports would fall

Capacity Utilization

If there's lots of excess capacity, firms can expand production without spending

Expectations

If you think there's going to be a recession and you will lose your job, your consumption decreases

Prices

In relative terms, higher domestic prices make foreign goods more attractive, so net exports drop

Long-term effects:

In the long run, tightness in the resource markets, particularly in the labor markets, will drive up production costs, and shift AS to the left.

Cost push inflation

Increases in production costs cause firms to raise prices to avoid losses.

Demand pull inflation

Increases in total spending that are not offset by increases in the supply of goods and services cause the average level of prices to rise.

Excess reserves=

Legal reserves-required reserves

Demographics

More people will spend more, but spending patterns are also influenced by the composition of the population

What financial innovation, popularized in the late 90s, might have allowed lenders to accept a greater amount of risk?

Mortgage back security

Why is the Long Run Aggregate Supply Curve Vertical?

Most economists think the LR AS is a vertical line at the potential level of GDP. In the long run, wages and other resource costs would fully adjust too price changes.

Government policies

Net exports may drop if Japan puts restrictions on U.S. goods allowed into Japan, for example.

Technology

New ___ stimulates business spending because firms must stay current to compete

In the ample reserves framework, what rate acts like a floor for the FFR?

ON RRP

medium of exchange

People will accept money in exchange for goods and services. Barter requires a double coincidence of wants - you have to find somebody who both has what you want AND wants what you have in order to trade

Discount Rate

Rate at which the Fed lends to eligible institutions: Increasing the ___ decreases the money supply

Required reserves=

Reserve requirement ratio*checkable deposits

Net Exports

Spending by Foreigners

Consumption

Spending by households

Store of Value

Store purchasing power

Factors that affect AS

TREES

TREES

Technology, Resource Prices, Expectations, Economic Growth, Supply Shocks

Interest on excess reserves (IOER)

The Fed lowers the ___ to decrease the federal funds rate. If the federal funds rate drops below ___, banks will borrow at the federal funds rate and deposit the funds in their accounts at the Fed, driving the federal funds rate up

Overnight Reverse Repurchase agreements (ON RRP):

The Fed sells securities to eligible institutions, and buys them back the next day for a higher price. Eligible institutions will not lend below this rate, because they can get this rate risk-free from the Fed. The rate on ___ acts as a floor for the federal funds rate.

Why does short run AS slope up?

The prices of inputs tend to be fixed by contracts (like labor contracts), so firms can increase the prices of their output more quickly than their costs rise. This increased profitability per unit causes them to produce more output as the price level rises.

Progressive income tax

The tax rate rises as income rises in percentage terms.

Thinking in terms of a supply and demand graph, how did the Financial Crisis move the supply of reserves?

They moved the supply curve right into the flat portion of the demand curve

Interest rate effect

When the price level increases, interest rates rise and (household and) business spending declines

Cost of Capital Goods

___ are goods that firms buy to use in making other goods. These goods give no pleasure in themselves, but only 2 are desirable because they make something else. If the cost of capital goods increases, business spending decreases.

Legal reserves

assets defined to be legal reserves (vault cash and deposits at the Fed)

Open Market Operations

buying and selling Treasury and government agency securities to change the money supply. To increase the money supply, the Fed buys bonds. (the most important tool)

Fiscal Policy

changing government spending and taxes to stabilize the economy

Monetary Policy

changing the money supply to stabilize the economy

Contractionary fiscal policy

decreasing government spending and increasing taxes to decrease AD, used to fight inflation

Expansionary fiscal policy

increasing government spending and decreasing taxes to increase AD; used to fight unemployment

Effects of deficits

may raise interest rates if financed by borrowing. Higher interest rates

Functions of Money

medium of exchange, unit of account, store of value

Automatic Stabilizers

policy that is automatically set in motion to increase government spending /decrease taxes to fight unemployment or decrease government spending/increase taxes to fight inflation. Congress does not act

Investment

spending by business firms

Federal Funds Rate

the interest rate that banks charge each other for reserves. All other interest rates move with this rate.

Reserve requirement

the ratio of a bank's deposits that must be kept on reserve and cannot be lent out. Increasing the ___ decreased the money supply. (least used tool) The Fed did away with the ___ in 2020

Regressive tax

the tax rate decreases as the tax base changes.

Proportional tax

the tax rate does not change as the tax base changes.

Aggregate Demand

the total quantity of an economy's final goods and services demanded at different price levels

Aggregate Supply

the total quantity of an economy's final goods and services produced in the economy at different price levels. Anything that affects the costs of production will affect___

Unit of Value

to measure the value of goods and services

Wealth Effect

when the price level goes up, and the amount of income and financial assets that people have doesn't change, they can't buy as much