Macro Economics

Federal Open Market Committee

(FOMC) A twelve-member committee that is composed of members of the Board of Governors of the Fed and selected presidents of the regional Federal Reserve Banks. It oversees open market operations (the buying and selling of government securities), the main tool of monetary policy.

What are the three main criticisms of using expansionary fiscal policy?

1. Potential Inflation 2. Budget Deficit (A higher budget deficit will require higher taxes in the future and may cause crowding out.) 3. Crowding-out effect. (When deficit spending requires the Government to borrow, interest rates are driven up, reducing consumer spending and business investment)

Hawks and doves

A hawk is someone who advocates keeping inflation low as the top priority in monetary policy Doves generally are more in favor of expansionary monetary policy, including low interest rates, while hawks tend to favor "tight" monetary policy.

Macroprudential monetary policy

A macroprudential monetary policy is one that takes into account the stability of the financial system as a WHOLE. Under a macroprudential monetary policy, decisions would more likely be made to preserve the existence of financial institutions, rather than to meet targets for interest rates, inflation rates, and the level of employment. Therefore, it is less of a tool for stabilization policy and more of a tool for financial security. Macroprudential policies typically set a target for the level of net worth banks need to maintain. This is typically referred to as a capital cushion.

Fiscal sustainability

A measure of the present value of all projected future revenues compared to the present value of projected future spending.

Transfer payments

A payment made or income received in which no goods or services are being paid for, such as a benefit payment or subsidy. (income redistribution by giving out money under social welfare programs such as social security, old age or disability pensions, student grants, unemployment compensation, etc)

Real and nominal interest rates

A real interest rate is the interest rate that does take inflation into account. As opposed to the nominal interest rate, the real interest rate adjusts for the inflation and gives the real rate of a bond or a loan.

Automatic stabilizers

Automatic stabilizers are economic policies and programs designed to offset fluctuations in a nation's economic activity without intervention by the government or policymakers on an individual basis. The best-known automatic stabilizers are corporate and personal taxes, and transfer systems such as unemployment insurance and welfare. Automatic stabilizers are so called because they act to stabilize economic cycles and are automatically triggered without explicit government action.

Bank reserves

Bank reserves are a commercial banks' holdings of deposits in accounts with a central bank

Vault Cash

Cash kept on hand in a depository institution's vault to meet day-to-day business needs, such as cashing checks for customers; can be counted as a portion of the institution's required reserves.

Cost-push inflation

Cost push inflation is inflation caused by an increase in prices of inputs like labour, raw material, etc. The increased price of the factors of production leads to a decreased supply of these goods.

Demand-pull inflation

Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces aggregate supply. "Too much money chasing, too few goods"

Fractional reserve banking system

Describes a banking system in which a portion of bank deposits are held as vault cash or in an account with the regional Federal Reserve Bank, while the rest of the deposits are loaned out to generate the money creation process.

Excess reserves

Excess reserves are capital reserves held by a bank or financial institution in excess of what is required by regulators, creditors or internal controls. For commercial banks, excess reserves are measured against standard reserve requirement amounts set by central banking authorities.

Fiscal Policy Keynesian Cross

Expansion moves to the right Contraction moves to the left

Contractionary monetary policy

Fed actions designed to decrease the money supply and raise interest rates to shrink income and employment, usually to fight inflation.

Expansionary monetary policy

Fed actions designed to increase the money supply and lower interest rates to stimulate the economy (expand income and employment)

Fiscal policy

Fiscal policy is use of the government budget to stabilize the business cycle. (Deals with BONDS and Taxes, Government spending)

*Forward guidance

Forward guidance is when the Central Bank announces to markets that it intends to keep interest rates at a certain level until a fixed point in the future. The aim of forward guidance is to influence long term interest rates and market expectations. The Fed has employed forward guidance as a way of signaling its policy intentions to markets. FOMC announcements now include a statement about expected interest rate changes or other monetary manipulations in store for the medium-term future, roughly one to two years out.

Functional finance

Functional finance is an economic theory proposed by Abba P. Lerner, based on effective demand principles and chartalism. It states that government should finance itself to meet explicit goals, such as taming the business cycle, achieving full employment, ensuring growth, and low inflation. (Government Intervention in the business cycle)

Keynesian Cross AS/AD

In Terms of Aggregate Demand. A shift to the right means an increase in AD and a shift to the left means a decline in AD

Mandatory Spending

In United States fiscal policy, mandatory spending is government spending on certain programs that are required by existing law. (Like Social Security Medicare and interest on national debt)

Liquidity trap

In a liquidity trap, an increase in the money supply does not result in a decrease in interest rates; thus, there is no change in investment, and consequently no change in income or output.

FOMC announces a target range for the federal funds rate.

In its official policy statements every six weeks, the Federal Open Market Committee announces a target range for the federal funds rate. It then uses open market operations to adjust the supply of reserves in the banking system so that the supply of reserves will intersect with the demand for reserves at exactly the target federal funds rate. When the Federal Reserve buys bonds, deposits at the Fed are created to pay for the bonds, thereby putting downward pressure on the federal funds rate. When the Federal Reserve sells bonds, deposits at the Fed are erased in the banking system, which will tighten competition for those funds and cause the actual federal funds rate to rise.

Quantitative easing

In quantitative easing, central banks target the supply of money by buying or selling government bonds. When the economy stalls and the central bank wants to encourage economic growth, it buys government bonds. This lowers short-term interest rates and increases the money supply.

SRAS

In summary, aggregate supply in the short run (SRAS) is best defined as the total production of goods and services available in an economy at different price levels while some resources to produce are fixed. ... As prices increase, quantity supplied increases along the curve.

Internal and External Public Debt

Internal debt or domestic debt is the part of the total government debt in a country that is owed to lenders within the country. (Commercial banks, other financial institutions etc.) External debt is the portion of a country's debt that was borrowed from foreign lenders including commercial banks, governments or international financial institutions.

Main tool of traditional monetary policy

Keep in mind that the main tool of traditional monetary policy is open market operations. This tool is used on a daily basis, even in ordinary times. It is closely tied with the federal funds rate. The federal funds rate is a market-determined interest rate that banks pay on overnight loans between one another. You can think of it as the equilibrium price of overnight funds within the private banking system.

What's the difference between keynesian and supply-side economics?

Keynesian economists once tried to promote growth through government deficit spending. Supply-side economists suggest we promote growth through tax cuts and deregulation.

*Solvency vs. liquidity

Liquidity ratios and solvency ratios are tools investors use to make investment decisions. Liquidity ratios measure a company's ability to convert its assets to cash. On the other hand, solvency ratios measure a company's ability to meet its financial obligations. A bank is solvent if it has a positive net worth. A bank is liquid if it has sufficient assets to be converted to cash to cover the withdrawals on any given day.

M1 and M2

M2 is a calculation of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.

Open market operations (In Depth)

Open market operations (transactions of U.S. Treasury securities between banks and the Federal Reserve) are used to influence the level of deposits at the Fed in the banking system as a whole. When the level of deposits at the Fed increases, the federal funds rate decreases because there is less competition to borrow reserves. When the level of deposits at the Fed decreases, the federal funds rate increases. Deposits at the Fed are created when the Fed buys bonds from banks. These same deposits are erased when the Fed sells bonds to banks. What are the balance sheet entries that show the change in reserves resulting from open market operations?

Stagflation

Persistent high inflation combined with high unemployment and stagnant demand in a country's economy.

Supply-side fiscal policies

Policies that focus on moving the LRAS curve to the right, expanding the economy without increasing inflationary pressures. It usually includes lowering taxes and interest rates, and limiting government interference.

Multiplier

Spending changes alter equilibrium income by the spending change times the multiplier. One person's spending becomes another's income, and that second person spends some (the MPC) which becomes another income for another person, and so on, until income has changed by 1/(1-MPC)= 1/MPS. The multiplier operates in both directions.

Monetary Policy

The Fed can pursue an expansionary monetary policy by buying bonds from banks in open market operations. The Fed can pursue a contractionary monetary policy by selling bonds to banks in open market operations (DEALS WITH INTEREST RATES)

Board of Governors in Washington, DC

The Fed's Board of Governors consists of seven members who are appointed by the president and confirmed by the senate. The Board of Governors' staff of nearly 2000 helps the Fed carry out its responsibilities for monetary policy, and banking and consumer credit regulation.

What is the LRAS

The Long-Run Aggregate Supply curve represents the full employment capacity of the economy and depends on the amount of resources available for production and the available technology. Changes in resources, labor, technology etc. can shift the LRAS curve to the right at a new full employment output.

Federal deficit

The amount by which a government's expenditures exceed its tax revenues. The difference is made up for by borrowing from the public through the issuance of debt. also called Federal Debt.

Bank balance sheet

The balance sheet identity is: Assets = Liabilities + Capital. The assets are items that the bank owns. This includes loans, securities, and reserves. Liabilities are items that the bank owes to someone else, including deposits and bank borrowing from other institutions.

Open market operations

The buying and selling of U.S. government securities, such as Treasury bills and bonds, to adjust reserves in the banking system.

Discount rate

The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank

Discount window

The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.

Federal funds rate

The interest rate financial institutions charge each other for overnight loans used as reserves.

Dual mandate (Statutory mandate)

The monetary policy goals of the Federal Reserve are to foster economic conditions that achieve both stable prices and maximum sustainable employment. (STABLE PRICES AND SUSTAINABLE EMPLOYMENT)

Discretionary spending

The part of the budget that works its way through the appropriations process of congress each year and includes national defense, transportation, science, environment, and income security.

Public debt

The portion of the national debt that is held by the public, including individuals, companies, pension funds, along with foreign entities and foreign governments.

Reserve requirement

The required ratio of funds that commercial banks and other depository institutions must hold in reserve against deposits.

National debt

The total debt issued by the U.S. Treasury, which represents the total accumulation of past deficits. A portion of this debt is held by other government agencies and the rest is held by the public. It is also referred to as "Gross Federal Debt"

Recessionary gap

This is a situation wherein the real GDP is lower than the potential GDP at the full employment level. The economy operates below the full employment level in a recessionary gap

Federal funds market

Transactions in the federal funds market enable depository institutions with reserve balances in excess of reserve requirements to lend reserves to institutions with reserve deficiencies. These loans are usually made for one day only, that is, "overnight".

Twelve regional (district) Federal Reserve banks

Twelve Federal Reserve Banks and their branches perform a variety of functions, including providing a nationwide payments system, distributing coins and currency, regulating and supervising member banks and serving as the banker for the U.S. Treasury.

Crowding-out effect

When deficit spending requires the Government to borrow, interest rates are driven up, reducing consumer spending and business investment

*Zero lower bound

Zero lower bound (ZLB) is a macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the capacity that the central bank has to stimulate economic growth The zero lower bound refers to the conventional wisdom that nominal interest rates cannot fall below zero, even though real interest rates often are below zero.

Full-employment level of income

a maximum level of output where everyone available is employed and no more output can be produced.

If the actual Federal funds rate were below the target rate, the Federal Reserve would:

sell Treasury bills on the open market.