Econ Final (Ch 13, 14, 16, 17)
What are the different types of Money?
Commodity money: The use of an actual good for money. • Historically the first medium of exchange in an economy. Commodity-backed money: Money you can exchange for a commodity at a fixed rate. • Solves transportation problem of using commodity money. Fiat money: Money with no value except as the medium of exchange. • No inherent or intrinsic value to the currency
What is money and currency?
Currency: The paper bills and coins used to buy goods and services. Money: Any generally accepted means of payment. Functions: 1. Medium of exchange 2. Unit of account 3. Store of value
What is the Federal Deposit Insurance Corporation (FDIC)?
Between 1929 and 1933, 9,000 banks failed. In 1933, the U.S. government instituted federal deposit insurance through the Federal Deposit Insurance Corporation (FDIC): • Government program that insures your bank deposits. • Goal: increase bank stability, decrease bank runs. • Created moral hazard situation: • Moral hazard: lack of an incentive to guard against risk.
What is the Simple money multiplier and its formula?
Simple money multiplier: The rate at which banks multiply money when all currency is deposited into banks and they hold no excess reserves. Realistically: •Represents maximum size of money multiplier.
Marginal Income Tax Rates
Some politicians consistently call for tax cuts, even with large deficits •Tax cuts can stimulate work effort, employment, and income. But: •If the tax rate is too low, the government will not generate enough revenue. •If the tax rate is too high, people will work less and the tax base will shrink. How can we find the optimal tax rate?
What is a Store of value:
Store of value: A means for holding wealth. Today, we have other options for holding our wealth. Examples: bank accounts, savings accounts, stocks, bonds.
What is the Supply-side fiscal policy:
Supply-side fiscal policy: The use of government spending and taxes to affect the production (supply) side of the economy. • Target the LRAS curve. • Factors that shift LRAS: Changes in resources, technology, and institutions. • They increase incentives for productive activities. • Policies often take time, so supply proposals are emphasized as long-run solutions for growth.
What is the spending multiplier and formula ?
The total impact of fiscal policy is a multiple of the original spending created. Spending multiplier: A formula to determine the equation's effect on spending from an initial change of a given amount
What are the shortcomings of Fiscal Policy
There are three reasons why fiscal policy does not always work: 1. Time lags Recognition lag: It is difficult to determine when the economy is turning up or down. • GDP data is released quarterly and revised later. • Unemployment rate data lags even further. • Growth is not constant. Implementation lag: It takes time to implement fiscal policy. • Fiscal policy must pass as legislation. Impact lag: It takes time for effects of policy to materialize. • Multiplier effects occur over time. Automatic stabilizers: Government programs that naturally implement countercyclical fiscal policy in response to economic conditions. • Can eliminate recognition lags and implementation lags. Examples: • Progressive income tax rates • Corporate profit taxes • Unemployment compensation • Welfare programs 2. Crowding-out Crowding-out: When private spending falls in response to increases in government spending. This reduces the ability of government spending to stimulate aggregate demand. Implications: •Overall spending may not increase. •Government now has higher deficit and debt. 3. Savings adjustments
T or F : During economic expansions, GDP growth is typically positive while during recessions it is typically negative
True
T or F : In recessions unemployment rises, while in expansions unemployment falls.
True
What is true about the magnitude of the Great Depression? A. Output fell by 4% during the Depression. B. A large increase in the money supply almost caused hyperinflation. C. Prices rose higher than at any time in the previous century. D. Unemployment reached a level of 25%
Unemployment reached a level of 25%.
What is a unit of account?
Unit of account: The measure in which prices are quoted. • Creates a common language and unit of measurement. • Enables people to make accurate comparisons between items. • Creates a consistent method of record keeping
Shift Factors in Aggregate Demand
When people's demand for goods and services at all price levels changes, AD will shift. The main categories are: - Consumption Consumption spending accounts for about 70% of all spending inGDP. Consumption is influenced by: 1. Changes in real wealth. • Stock market rises or falls. • Widespread change in real estate values 2. General expectations about the future. • Changes in expected income. • Change in consumer confidence 3. Changes in taxes - Investment Investment shifts when decision-makers at firms decide to increase or decrease spending on capital goods. 1. Investor confidence. • As investor confidence rises, so does investment. 2. Interest rates. • At lower interest rates, investment increases. 3. Quantity of money in the economy • More money will lead to lower interest rates, which will increase investment. 3. Government Spending Factor influenced most directly by policymakers. These changes may be made in response to economic conditions. Example: If people become more pessimistic about the future, the government might decide to spend on roads and highways to offset the decrease in consumption and investment. 4. Net Exports Net exports shift in response to changes in foreign income and the value of the U.S. dollar. As income in other nations rises, their demand for U.S. goods increases. • As nations become wealthier, net exports increase. When the value of the dollar increases, people in the U.S. can buy more foreign goods but people outside of the U.S. can buy less U.S. goods. So, net exports decrease. • A stronger dollar leads to a decline in net exports.
What was the Economic Stimulus Act 2008:
it was a Great Recession Fiscal Policy • Signed by President Bush • Tax rebate for Americans • Totaled $168 billion • Typical family of four received $1,800 •Goal: Increase consumption, stimulate the economy
What was the American Recovery and Reinvestment Act 2009?
it was another Great Recession Fiscal Policy • Signed by President Obama • Focused on government spending • $787 billion stimulus •Goal: Increase aggregate demand
Commodity Money versus Fiat Money
Commodity money • Links money to something tangible. • Limits inflation. • Fluctuations in the commodity value changes all prices. • New gold discovery leads to inflation. Fiat money • Not backed with a commodity. • Not subject to macroeconomic risk by changing commodity value. • Subject to rapid monetary expansion and inflation.
What is the Marginal propensity to consume (MPC) and its formula?
(MPC) : The portion of additional income spent of consumption. • MPC is not constant across all people. • 0 ≤ MPC ≤ 1.
How do changes in the price level affect the supply decisions of the firm?
- It depends. - Economists use two different time horizons: 1. Long-run - Long run: A period of time sufficient for all prices to adjust. • The level of output produced when an economy is at the natural rate of unemployment (u*). • It depends on an economy's resources, technology, and institutions. - Vertical line: • Not affected by changes in price. • An economy's ability to produce is the same regardless of how much paper money is present. - Shifts in Long-Run Aggregate Supply LRAS changes when a nation's ability to produce output changes. • This occurs with changes in: 1. Resources 2. Technology 3. Institutions 2. Short-run - Short run: The period of time in which some prices have not yet adjusted. - There are three reasons why there is a positive relationship between the price level and the quantity of aggregate supply: • Sticky input prices • Menu costs • Money illusion - Shifts in Short-Run Aggregate Whenever the long-run AS curve shifts, it takes the short-run AS curve with it. Factors that shift only the short-run AS curve: 1. Changes in resource prices 2. Changes in expectations of prices 3. Supply shocks: surprise events that change a firm's production costs
What are the three reasons why there is a positive relationship between the price level and the quantity of aggregate supply:
1 Sticky input prices - Resource prices tend to be sticky because they are often set by written contract. • Example: Workers might sign a two-year contract for a fixed wage. - Output prices are more flexible since they are generally easy to change by the company. • Example: Prices in a coffee shop can be written on a blackboard that can change day to day - Since input prices are sticky but output prices are not, when the price level increases companies can increase their profits by producing more. 2 Menu costs Menu costs: The costs of changing prices. - Because of this expense, firms do not adjust their output price when the price level changes. • This will impact the amount customers will want. • The quantity of aggregate supply will adjust to meet this change in the quantity of aggregate demand. 3 Money illusion - Money illusion: Occurs when people interpret nominal changes in wages or prices as real changes. - Workers are very reluctant to accept pay decreases, even if the pay decrease is nominal. • Firms will reduce output in response to decreases in the price level rather than cut wages.
1. Example: Adjustment in Long-Run AS 2. Example: Adjustment in Short-Run AS 3. Example: Adjustment in Aggregate Demand
1. Example: Adjustment in Long-Run AS Suppose that there is a technology shock. Which curves shift? • Both LRAS and SRAS. In what direction? • To the right. What happens to output, employment, price level? • Output increases. • Employment stays the same. • Price level goes down. 2. Example: Adjustment in Short-Run AS Suppose that there is an important oil pipeline leak. Which curves shift? • Just SRAS.In what direction? • To the left.What happens to output, employment, and price level in the short run? • Output falls. • Unemployment increases. • Price level goes up. 3. Example: Adjustment in Aggregate Demand Suppose that consumer confidence rises. Which curves shift? • AD.What direction? • To the right.What happens to output, employment, and price level in the short run? • Output increases. • Unemployment goes down. • Price level rises. Example: Adjustment in Aggregate Demand (2/3) How do we get back to long-run equilibrium? • SRAS shifts left. What happens to output, employment, and price level in the long run? • Output stays the same. • Employment stays the same. • Price level goes up.
In macroeconomics, what are two paths of study:
1. Long-run growth and development 2. Short-run fluctuations, or business cycles Long-run growth and development. • Focuses on theories and policies that affect economies over several decades. Short-run fluctuations, or business cycles • Focuses on time horizons of five years or less.
The three reasons why quantity of aggregate demand and the price level are negative are:
1. The wealth effect. Wealth effect: The change in the quantity of aggregate demand that results from wealth changes due to price-level changes. Wealth: The net value of one's accumulated assets. This effect is related to consumption. Example: If real estate prices drop, people that have stored their wealth in the form of homes will consume less. 2. The interest rate effect. Interest rate effect: Occurs when a change in the price level leads to a change in interest rates and therefore in the quantity of aggregate demand. This occurs through the loanable funds market.• Changes in the price level affect saving.• This directly impacts the supply of loanable funds. Example: If price levels rise, people will save less which will increase interest rates. This will decrease investment. 3. The international trade effect. International trade effect: Occurs when a change in the price level leads to a change in the quantity of net exports demanded. Happens due to changes in relative price levels. Example: If Japanese goods are cheaper relative to U.S. goods, more people will demand Japanese goods.
What are recessions caused by?
1. declines in AD. Aggregate demand can decline for a number of reasons. When AD shifts left, unemployment goes up, output goes down, and the price level declines. In the long run, short-run aggregate supply adjusts to bring the economy to equilibrium. • Can be a lengthy and painful process. • Government can minimize these effects. • The most useful policies are demand-stimulating policies (spending increases, tax cuts, and expansion of money supply) 2. declines in AS. Declines in aggregate supply can be caused by shifts in both long-run and short-run AS curves. Recessions caused by short-run AS shifts occur when input costs rise. • By itself, it is a fairly harmless, quick recession. • Danger of triggering deeper recession. Recessions caused by long-run AS shifts are caused by negative changes in resources, technology, and institutions. • Leads to permanent changes in an economy
Bank Balance Sheet
A bank's balance sheet has two sides: • The first side is assets: • Assets: The items a firm owns. • The second side is liabilities plus owner's equity: • Liabilities: The financial obligations a firm owes to others. • Owner's equity: The difference between a firm's assets and its liabilities. The sums of both sides of the balance sheet have to equal each other.
Why is M2 currently a more monitored measure of the money supply than M1? A. ATMs have allowed easier access to savings deposits. B. M2 doesn't include coins, which may be obsolete in a few years. C. Banks pressured the Fed to include savings in the money supply measure. D. People have increased use of credit cards.
A. ATMs have allowed easier access to savings deposits.
Suppose there is an increase in AD, causing a price level increase; what will happen in the long run as prices adjust? A. The price level will go back to its previous level. B. The price level will rise even further. C. The price level will fall to a level below its previous level. D. The price level will fall slightly to a level some where between its current level and the original level.
B. The price level will rise even further.
Classical economists will generally focus on policies that will A. cause short-run AD changes. B. emphasize increasing the LRAS. C. cause people to spend less money. D. prevent GDP from increasing too fast.
B. emphasize increasing the LRAS
What is aggregate demand?
The total demand for final goods and services in an economy. It is the sum of spending in the economy.
What is. Countercyclical fiscal policy:
All else equal, an economy that grows at a consistent rate is preferable to an economy that grows in an erratic fashion. Countercyclical fiscal policy: Fiscal policy that seeks to counteract business cycle fluctuations. • Expansionary policy during recessions. • Contractionary policy during expansions. The government tries to shift AD back to a long-run equilibrium faster than without government intervention.
What was one of the main catalysts of the Great Recession, which began in December 2007? A. A large tax increase. B. Falling real estate prices. C. Bad monetary policy, which increased the money supply too much. D. A lack of skilled labor.
B. Falling real estate prices.
Today in the United States, the dollar ($) is: A. intrinsically valued money. B. fiat money. C. commodity money. D. commodity-backed money.
B. fiat money
How did the Macroeconomic policy affect the Great Depression?
Between 1928 and 1929 policymakers believed stock prices were too high so the government reduced the money supply. • Lower money supply caused panic and led to the failure of more than 9,000 banks. Presidents Hoover and Roosevelt raised taxes to try to balance the federal budget. • Higher taxes reduced even further aggregate demand. Congress passed the Smoot-Hawley Tariff Act. • This set off a trade war and reduced U.S. export
The Great Depression led to the creation of what school of thought in economics? A. Classical B. Keynesian C. Ricardian D. Smithian
B. Keynesian
Supply-side fiscal policy initiatives include:
• R&D tax credits • Education policies (subsidies or tax breaks) • Lower corporate profit tax rates • Lower marginal income tax rates
Which of the following is an example of expansionary fiscal policy? A. increase in taxes B. stimulus package C. increasing the money supply D. lowering interest rates
B. stimulus package
Consider just the AD curve. Suppose consumption (C) broadly increases across the entire economy. This will cause A. a movement along the AD curve. B. the AD curve to shift outward. C. the slope of the AD curve to get steeper. D. a decrease in the price level of the economy.
B. the AD curve to shift outward.
The wealth effect can help explain A. the positive slope of the AS curve. B. the negative slope of the AD curve. C. the difference between real and nominal GDP. D. the rate of economic growth.
B. the negative slope of the AD curve.
Why do banks charge interest rates?
Banks charge more interest for loans than they pay for deposits. The difference pays the banks' expenses and produces profits.
What is the importance of banks?
Banks have two important roles in the economy: 1. They are critical participants in the loanable funds market. 2. Play a role in determining the money supply. Their function is to serve as a financial intermediary.
Why do bank hold deposits ?
Banks hold deposits for two reasons: 1. To accommodate withdrawals by depositors. • Bank runs occur when many depositors attempt to withdraw their funds at the same time. 2. Because they are legally bound to hold a fraction of their deposits on reserve. • Required reserve ratio (rr): The portion of deposits that banks are required to keep on reserve. • Required reserves = rr × deposits. • Excess reserves are any bank reserves held in excess of those required.
Why is the LRAS curve vertical? A. The short run sets a given output that will remain in the long run. B. Long-term output can only increase at a specific equilibrium price level. C. Price shave nothing to do with long-term output D. Unemployment is zero in the long run.
C. Price shave nothing to do with long-term output
What is the main reason Keynes believed that the economy won't return to equilibrium after a decrease in AD? A. The ineffectiveness of government intervention. B. People wanted to remain in the depression because of lower prices. C. Sticky wages. D. Imperfect information
C. Sticky wages.
Classical Economics vs Keynesian Economics
Classical Economics •Adjustment toward long-run equilibrium will happen naturally. •Prices are flexible. •Let the economy go and the market will correct itself. Classical Economists believe: Economy is self-correcting: •Generally believe in the AD-AS framework shown. •Economy comes back to full employment in the long run, no matter what curves shifted. •Adjustments generally occur quickly. Policies: •Pro-market, laissez-faire. •No significant role for government intervention in macroeconomic policy. •Focus on long-run growth (shifting LRAS) rather than AD shifts. Keynesian Economics •Adjustment will be long and occur unpredictably with many delays. •Prices are sticky. •Call for government interventions in the market. Keynesian Economists believe: Main argument: "In the long run, we are all dead." Focus on the demand side of the economy as the source of instability. Government intervention is needed in prolonged recessions to boost demand and restore the economy to long-run equilibrium. • Since aggregate demand is the main source of stability, government has to intervene.
Banks increase the money supply by: A. printing (minting) money. B. controlling interest rates. C. lending out funds to borrowers. D. storing the money of savers.
C. lending out funds to borrowers
Discount loans are: A. loans offered by private banks at a lower interest rate. B. cheap loans to individuals from nonbank businesses. C. loans from the Fed to private banks. D. loans private banks make to each other.
C. loans from the Fed to private banks.
Which of the following is an example of an automatic stabilizer? A. Federal Reserve interest rates B. discretionary outlays C. progressive income taxes D. education subsidies
C. progressive income taxes
Suppose the MPC is 0.9. What will the total GDP impact be of a $400 billion increase in government spending (G)? A. $360 billion B. $760 billion C. $1 trillion D. $4 trillion
D. $4 trillion
With a reserve requirement of 5% and an initial deposit of $400, what is the total amount of money that could be in the money supply? A. $420 B. $780 C. $4,000 D. $8,000
D. $8,000
What is The Laffer Curve?
During the 1980s, marginal tax rates were cut . . . • Tax revenue per taxpayer fell, suggesting that lower taxes decrease revenue. • However, taxes paid by the top 1% increased. • This data confirms the existence of the two regions of the Laffer curve. In Region I, where tax rates are low, increases in tax rates increase tax revenue. In Region II, where tax rates are high, increases in tax rates decrease tax revenue.
With the AD-AS graph, what variable is on the vertical axis? A. National income. B. The price of the good we are studying. C. The price of labor. D. The price level.
D. The price level.
Which of the following is an example of contractionary fiscal policy? A. decreasing the money supply B. increasing the interest rate C. increasing government spending D. increasing taxes
D. increasing taxes
Debit Cards vs Credit Cards
Debit cards: • Access checking and/or savings accounts. • Checking and savings accounts are included in M2. Credit cards: • Technically not a part of the money supply. • Involve a loan made at the cash register. • Bank deposits from elsewhere pay for the purchase.
What caused the Great Depression?
Decline in Aggregate Demand in Great Depression The Great Depression was caused by a decline in aggregate demand which was driven by: decline in real wealth: • Stock market crash in October 24, 1929. • Between 1929 and 1932, stocks fell by almost 90%. decline in consumer confidence: • People became pessimistic over the future due to the stock market crash. flawed macroeconomic policy.
Expansionary vs Contractionary Fiscal Policy
Expansionary Policy • Government increases spending or decreases taxes to stimulate or expand economy. • Leads to government deficits. When the economy is slowing, the prescription is for expansionary fiscal policy: 1. Increasing government spending: • Increasing government spending will increase AD (since G is one component of AD), which increases GDP. 2. Decreasing taxes: • Decreasing taxes will raise disposable income and consumption, which will also increase AD and GDP. When government spending increases and taxes decrease, budget deficits increase. • Government finances this gap by borrowing. Example: • During a recession, incomes fall and unemployment rises. • Government spending increases by $500 billion. • Tax revenues decrease. • Deficit and debt rise by more than $500 billion Contractionary Policy • Government decreases spending or increases taxes to attempt to slow economy. • Pay off government debt. • Keep economy from expanding beyond long-run capabilities. Decrease AD by decreasing government spending or increasing taxes in order to: 1. pay off debt that was accrued due to expansionary fiscal policy during bad times. 2. slow down economy that is "overheated" from too much spending, leading to inflation. •Not sustainable in the long run. •Try to reduce the upward pressure on price level. •Still interested in "smoothing" out cycles.
What is Fiscal Policy?
Fiscal policy: The use of government's budget tools, government spending, and taxes to influence the macroeconomy. Legislated and approved by both Congress and the president
What caused the Great Recession?
Initially, economists and policymakers believed the Great Recession was caused by lower aggregate demand. Hindsight reveals that aggregate supply also fell. Long-run aggregate supply fell due to: an institutional breakdown in the loanable funds market. : There was an institutional breakdown in the loanable funds market. • Real estate values fell in 2007. •As a result of securitization, falling real estate values led to a systematic problem in financial markets. new regulations. : New regulations were placed to prevent another breakdown in the loanable funds market. •Dodd-Frank Act: The primary regulatory response to the financial turmoil that contributed to the Great Recession. While institutional breakdowns affected aggregate supply, aggregate demand was also affected by: •decrease in wealth: •Real estate is often the single largest portion of wealth. • Stocks lost one-third of their value in 2008. •decrease in expected income: •People realized the economy was faltering. •Consumer spending decreases during times of uncertainty Consumer confidence started decreasing even before the Great Recession and remained low even after the recession was over.
John Maynard Keynes
John Maynard Keynes, British economist: •The General Theory of Employment, Interest, and Money (1936) •Theory of persistent cyclical unemployment. •Believed that wages are "sticky downward," meaning that wages, by their nature, are very reluctant to ever decrease, even during terrible economic conditions. •High wages prevent labor markets reaching equilibrium and restoring full employment, creating a prolonged recession.
Measuring the Money Supply
M1 • The money supply measure composed of currency and checkable deposits. • Checkable deposits are deposits in bank accounts from which depositors may make withdrawals by writing checks M2 • The money supply measure that includes everything in M1 plus savings deposits, money market mutual funds, and small-denomination time deposits (CDs).
What is Macroeconomic Policy?
Macroeconomic policy: Encompasses governmental acts that influence the macroeconomy. There are two types of macroeconomic policy: 1. Fiscal policy: Comprises the use of the government's budget tools to influence the macroeconomy. 2. Monetary policy: involves adjusting the money supply to influence the macroeconomy
Bank Reserves
Reserves: The portion of bank deposits that are set aside and not loaned out. • Reserves include both currency in the bank's vault and funds that the bank holds in deposit at its own bank, the Federal Reserve. Banks seek to loan out the money they have, so they only keep a certain portion of deposits in their reserves. • Fractional reserve banking: When banks hold only a fraction of deposits on reserve.
What is a medium of exchange?
Medium of exchange: What people trade for goods and services. • Most modern economies have a common medium of exchange provided by the government. • Other examples: Tobacco in colonial times, cigarettes or mackerel in prison. Alternative would be to barter. Barter involves the trade of a good or service in the absence of a commonly accepted medium of exchange. • Inefficient because it requires double coincidence of wants which occurs when each party in an exchange transaction happens to have what the other party desires. A double coincidence is pretty unusual, which is why a medium of exchange naturally evolves in any exchange environment.
Movements along the AD Curve versus Shifts in the AD Curve
Movement along the AD Curve - Start with a change in the price level. - Affect the quantity of aggregate demand through the three effects. Examples: Wealth effect, interest rate effect, international trade effect
What is the New classical critique:
New classical critique: Increases in government spending and decreases in taxes are largely offset by increases in savings. When there is an increase in government spending or decrease in taxes . . . •People recognize that the government has borrowed funds so . . . •Individuals save to pay for higher future taxes, which reduces consumption. •Mitigates the initial purpose of the increase in government spending or decrease in taxes.
When was The Great Recession?
Officially from December 2007 to June 2009. •Longest recession since WWII. Named the Great Recession. •Longer in length than other recessions. •Deeper in effects than other recessions.
What is an open market operation?
Open market operations: The purchase or sale of bonds by a central bank. • Buys securities → increase the money supply. • Sells securities → decrease the money supply. When performing OMO, the Fed typically buys and sells short-term Treasury securities for two reasons: • The Fed's goal is to get the funds directly into the market for loanable funds. • The market for Treasury securities is big enough to where the Fed can buy and sell without difficulty.
What is Quantitative Easing?
Quantitative easing: The targeted use of open market operations in which the central bank buys securities specifically targeting certain markets. During the Great Recession: • In late 2008, Fed injected almost $2 trillion worth of new funds. • Included $1.25 trillion in mortgage-backed securities. • Bought long-term Treasury securities in addition to targeting short-term ones.
What is a recession?
Recessions are short-term economic downturns typically characterized by declines in real GDP growth and increases in the unemployment rate.
What are Roles of the Federal Reserve?
The Fed acts as a "bank for banks." • It holds federal funds which are deposits that private banks hold on reserve at the Federal Reserve. • Banks keep reserves at the Fed because the Fed clears federal funds loans, loans between banks. • The interest rate on loans between private banks is called the federal funds rate. The Fed also acts as a lender of last resort. • Discount loans: Loans from the Fed to private banks • Discount rate: The interest rate on the discount loans made from the Fed to private banks. The Fed also serves as a regulator of individual banks. • Responsibilities include setting and monitoring reserve requirements.
What are the different Monetary Policy Tools
The Fed has several tools it can use to alter the money supply: 1. Open market operations 2. Quantitative easing 3. Reserve requirements 4. Discount rates
What is the Federal Reserve?
The Federal Reserve (Fed): Central bank of United States. Its three responsibilities are: 1. Monetary policy 2. Central banking 3. Bank regulation
What were the effects of The Great Depression?
The Great Depression was much worse than the Great Recession. Great Depression statistics: • Economy contracted by 30% from 1929 to 1933. • It took 7 years for real GDP to return to its pre recession level. • Unemployment was 2.2% in 1929 and 25% in 1933. • The unemployment rate was 15% for almost the entire decade of the 1930s While GDP declined about 4% in the Great Recession, during the Great Depression it declined by almost one third. The unemployment rate during the Great Depression reached 25% and stayed at 15% ten years after it started. At its highest point, the unemployment rate in the Great Recession was 10% The Great Depression was characterized by some unique conditions: •It was actually two separate recessions (1929 to 1933 and 1937 to 1938). •Most remarkable: Prices across the economy fell throughout the decade. •At the end of the 1930s, the price level was still 20% lower than 1929. •Indicates that the primary cause of the Great Depression was a decrease in AD.
What is a multiplier?
The initial effects of fiscal policy can snowball over time. Due to two central concepts: • Spending by one person becomes income to others. • Increases in income lead to increases in consumption.
What were the effects of The Great Recession?
• Significant problems in the financial markets, similar to what happened during the Great Depression. Even after the recession was over, unemployment recovered slowly and GDP grew slowly During the Great Recession, real GDP dropped significantly and took nearly four years to recover to pre-recession levels. Unemployment rose more than during other recessions and remained high even after the recession was over Second quarter of 2007 (prerecession): •Unemployment was below 5%. •Real GDP was growing at 3.6%. Fourth quarter of 2008 (during the recession): •Unemployment was 10%. •Real GDP declined at an annual rate of 8.9%. In 2012 (recession officially over): •Real GDP was growing at a rate of less than 2%. •Unemployment remained at 8%. •World financial institutions remained fragile. The Great Recession led to a permanent loss of real GDP that the U.S. economy may never recover.