Econ Adventure # 3

Incurring a federal budget deficit will increase the size of the public debt

TRUE

One significant characteristic of fractional reserve banking is that banks are vulnerable to panics or runs.

TRUE

One significant characteristic of fractional reserve banking is that banks create money through lending their reserves

TRUE

When a commercial bank makes a loan it monetizes the credit extended to a borrower

TRUE

State and local government fiscal policies _______ federal fiscal policy

offsetting State fiscal policy is pro-cyclical and annually balance their budgets

Financing war time expenditures by increasing internally-held public debt permits a nation to defer a part of the economic cost of war

FALSE

Fiscal policy refers to changing the level of government spending and taxes to achieve a greater equality in the distribution of income.

FALSE

Money must be created through the banking system

FALSE

Non-discretionary fiscal policy refers to Congress changing the tax and transfer payments system during a recession or inflationary boom to stabilize the size of government.

FALSE

One function of money is to serve as an encouragement to work

FALSE

One function of the Federal Reserve is to issue new government securities to finance a federal budget deficit

FALSE

Tax rates are an example of an automatic stabilizer

FALSE

The backing for the money in the United States comes from the confidence the public has in the ability of the President.

FALSE

The crowding-out effect suggests that increases in consumption are usually at the expense of saving.

FALSE

The gold stored at Fort Knox backs the paper money in the United States.

FALSE

The primary objective of fiscal policy is to stabilize the size of the federal debt

FALSE

The public debt is the accumulation of household, business, and government debt over time

FALSE

To keep inflation from eroding the value of money, policymakers in the United States establish insurance (FDIC) on checkable deposit accounts.

FALSE

To keep inflation from eroding the value of money, policymakers in the United States make paper money legal tender.

FALSE

To say money is socially defined means that society, acting through Congress, specifies what shall be money

FALSE

Your personal check drawn on a commercial bank is legal tender.

FALSE

A $10 billion increase in G is more expansionary than a $10 billion decrease in Tx because a portion of the tax cut will be saved

TRUE

During periods of hyperinflation, a nation's money may cease to function as a medium of exchange because people will not want to accept it in transactions.

TRUE

Paper money in the United States is a debt or liability of the Federal Reserve Banks

TRUE

Tax revenues are an example of an automatic stabilizer

TRUE

The backing for the money in the United States depends on its acceptability as a medium of exchange.

TRUE

Required to balance the budget (Economic boom)

Tax revenues must decrease and/ or government spending must decrease, this will worsen the inflation

Required to balance the budget (Recession)

Tax revenues must increase and/or government spending must decrease, this will worsen the recession

Consumption smoothing

Temporary change in taxes: spend a little save in case of an inc in prices Permanent change in taxes: spend a lot and not saving as much

When money serves as a means for determining the relative worth of an item money functions as a

Unit of account

Intrinsic value

Use or value in and of itself (eat a cow, spend the silver)

Net tax revenues

Vary directly with GDP

If C decreases then real GDP

decreases

If disposable income decreases by x, then consumer spending (C and S)

decreases

If taxes increase by x, then disposable income

decreases by x

Barter

exchanging of one good for another good (socially accepted) Trade requires a double coincidence of want, no common measure of value, and opportunity cost is high

Primary function of reserves

give the Fed influence over the lending ability of commercial banks by manipulating the reserve ratio or level of required reserves

A commercial bank temporarily short of required reserves may replenish reserves by

borrowing reserves in the federal funds market.

Easy money

pushes a recession into an expansion

Tight money

pushes an expansion into a contraction

Bank liabilities

sources of funds

Automatic stabilizers

"built in" to fed govt programs so the dollar amounts change do not suffer from timing problems: no recognition lag/ no administration lag

In a 100% reserve banking system the reserve ratio is ___% and the money multiplier is _____

100% ; 1

Check clearing

Bank against which a check is drawn and cleared loses both reserves and deposits Bank in which a check is deposited increase/gains both reserves and deposits

Banking system can create money up to a multiple of its excess reserves

Because the banking system cannot lose reserves.

Insufficient funds to meet its reserve requirements

Borrow reserves in the federal funds market

Commercial banks create money when they raise their interest rates

FALSE

Credit cards are a medium of exchange

FALSE

Individual commercials banks are limited in their ability to create money by lending because banking is a highly competitive industry

FALSE

The basic purpose of imposing legal reserve requirements on commercial banks is to assure the liquidity of commercial banks

FALSE

The primary reason commercial banks must keep required reserves on deposit at Federal Reserve Banks is to protect depositors from losses

FALSE

Profit-maximizing commercial bank

Liability attract funds at a low cost Asset management Liability management

Change in the behavior of households and commercial banks

Makes controlling the money supply more difficult

Multiple-deposit expansion of the banking system

Maximum money creating ability of the banking system

Money creating is reduced when

Public decides to hold more currency & Commercial banks decided to hold excess reserves

Simple money multiplier (m) assumes

Public does not hold any cash & banks fully loaned up hold no excess reserves

Commodity money

Refers to cows, gold, and silver

Required reserves

Reserve ratio set by the Fed Min reserve balance Checkable deposit liabilities x reserve ratio

Excess reserves

Single bank can lend only dollar-for-dollar with its excess reserves actual - required

Unregulated banking system

Vary the money supply to intensify the business cycle or destabilizes the economy

Commercial bank DESTROYS money

When deposits decrease and bank loans are repaid, banks sell government bonds to the public

Commercial bank CREATES money

When it uses its excess reserves to make a loan (monetizing an IOU) By bonds (exchanged for a check)

In a recession profit-motivated bankers will lend or create money in a way that causes the money supply to

decrease

In an economic boom, caused by demand-pull inflation, profit-motivated will lend or create money in a way that causes the money supply to

increase

In a regulated banking system

monetary policy is countercyclical

Currently, U.S. paper currency is issued by the

12 Federal reserve banks

Checkable deposits are included in M1 but not in M2

FALSE

Public (national) debt

Accumulation of federal budget deficits and surpluses over time Money owed by the federal government to holders of Treasury bills, Treasury notes, Treasury bonds, & US savings bonds Large public debt will not bankrupt the federal government liability to Americans as taxpayers and an asset to the owners of the government securities If the entire public debt is held internally by Americans, the liability would exactly offset the asset, or we would "owe it to ourselves"

Budget deficit (G > Tx)

Amount by which government expenditures exceed tax collections in a given year Makes up the difference by having the U.S. Treasury issue new U.S. securities Will be reduced and understated

Budget surplus (G < Tx)

Amount by which tax collections exceed government expenditures in a given year

A checkable deposit at a commercial bank is a(n) ________ to the depositor and a(n) ________ to the bank.

Asset/liability

100% reserve banking system

Banks are just a safe place to keep all the money Banks do not make loans with depositor's funds

Recession

Budget deficit automatically arises which is a countercyclical and stabilizing force in the economy

Demand-pull inflation (inflationary economic boom)

Budget surplus automatically arises which is a countercyclical, stabilizing force for the economy

Twelve Federal Reserve banks

Central banks, Quasi-public banks, Bankers for the commercial banks

Fiscal Policy

Changing the level of government expenditures and taxes to stabilize the economy and should be counter-cyclical

Expansionary fiscal policy

Close a recessionary gap by increasing aggregate demand

Contractionary fiscal policy

Close an inflationary gap (boom) by decreasing aggregate demand

Which of the following, cetreis paribus, would increase the money supply

Commercial banks buy bonds from the public

Discretionary/ Active fiscal policy

Congress actually meets to implement changes in government expenditures and/or taxes to close an output gap Actively manipulates aggregate demand

Federal Reserve Banks are owned by the Federal government

FALSE

Reserves

Deposits received by a bank but have not been loaned out Vault cash / deposits

Annually balanced budget

Destabilizes the economy, is not economically neutral, is pro-cyclical and will intensify the ups and downs

Externally held debt

Economic burden to Americans

Crowding-out of private investment

Economic burden to future generations

A budget deficit arises when federal government expenditures are increasing

FALSE

A contractionary fiscal policy is designed to decrease short-run aggregate supply

FALSE

A large U.S. public debt cannot bankrupt the federal government, leaving it unable to meet its financial obligations, because the government has the ability to decrease interest rates and increase investment spending

FALSE

Checkable deposits are assets of commercial banks

FALSE

Federal Reserve Act in 1913

Federal Reserve became the central bank of the United States ". . . to provide for the establishment of Federal Reserve banks, to furnish an elastic currency, to establish a more effective supervision of banking in the United States . ."

Federal Reserve Notes

Form of current paper money in the United States

Administrative lag

Inability to get quick action on fiscal policy necause of the way Congress operates "congress" makes discretionary fiscal policy and an ineffective way to stabilize and destabilizes the economy

An expansionary fiscal policy is designed to ____ aggregate ______

Increase aggregate demand

The economy is initially operating at its potential real GDP. Because of a deteriorating international political situation the federal government decides to increase military spending by $21 billion. At the same time policymakers decide to change the level of taxes to maintain full-employment, non-inflationary real GDP. Assume the MPC = 0.75 and the full multiplier effect is in effect. The level of taxes should be

Increased by 28 billion MPC x Change in income = Change in spending .75 x ? = 21 billion ? = 28 billion

Economic burden of war

Is the same regardless if the budget deficit is financed by higher taxes or borrowing Opportunity cost of war is the forgone civilian goods (PPF) and lives lost

A tax reduction of a specific amount will be more expansionary the _____ the economy's MPC.

Larger

Checkable deposits are

Liabilities to commercial banks

Money eliminates the need for a coincidence of wants because it functions as a

Medium of exchange

3 Functions of money

Medium of exchange: buy and sell stuff Unit of account: Way to compare relative value (price tag) Store of value: any asset is a store of value

Problems with implementing fiscal policy in an open economy

Net export effect arises because international flows of financial capital are seeking the best interest rate Net export effect weakens the impact of fiscal policy

Flat money

No intrinsic value, face value > intrinsic value

If the U.S. federal budget were balanced next year, the size of the U.S. public debt would _____

Not change

Face value

Of silver dollar is $1 but the intrinsic value is $20, If intrinsic value is greater than the face value, then it is taken out of circulation (not using a silver coin at DD)

Economic efficiency

Overcomes the problems associated with barter, Promotes specialization and trade, Increases real output and standard of living

Non-discretionary Fiscal Policy

Passive or automatic

Non-discretionary fiscal policy

Passively manipulates aggregate demand

Positive GDP gap

Problem: Economic boom Demand pull inflation Actual GDP > Potential real GDP Unemployment rate < natural rate Solution: Decrease agg demand Policy: Contractionary fiscal policy creates a budget surplus

Negative GDP gap

Problem: Recession High unemployment (cyclical) Actual GDP < Potential real GDP Unemployment rate > natural rate Solution: Increase agg demand Policy: Expansionary fiscal policy creates a budget deficit

Congress implements changes in Govt spending and taxes for

Purposes other than stabilizing the economy

The commercial banking system can lend by a multiple of its excess reserves because

Reserves lost by one bank will be gained by another

A wave of consumer and business optimism stimulates the economy. As a result GDP exceeds the economy's full-employment real GDP and the unemployment rate falls to 3%. The economic boom causes demand-pull inflation. In this situation proper counter-cyclical discretionary fiscal policy would involve

Running budget surplus

Board of Governors

Seven people appointed by the President, with the confirmation of the Senate

When people hold some of their wealth as money because it enables them to transfer purchasing power from the present to the future money functions as a

Store of value

Federal Reserve independence

The Federal Reserve is an independent agency within the federal government Fed does not get its funding through the regular congressional appropriations process 14-year terms

Recognition lag

Time between the beginning of a problem and the realization that there is a problem "data"

Operational lag

Time it takes a fiscal policy, once enacted, to be put into operation

Federal Open Market Committee (FOMC)

To assess economic conditions and make decisions regarding the conduct of open-market operations

Fraction of deposits "in reserve"

commercial banks hold less in reserves than the amounts they owe their depositors Banks can create money by using their excess reserves to make a loan Banks are vulnerable to bank panics or runs

Near-monies

highly liquid financial assets that do not function directly as a medium of exchange

Government expenditure and tax programs, automatic stabilizers

insulate individuals from the impact of aggregate demand shocks Tax revenues, unemployment compensation, & welfare payments

The claims of the non-owners of a bank against the bank's assets are called

liabilities

Checkable deposits are money because they are

socially accepted

Money

socially accepted as a medium of exchange or as payment for goods and services

Balance sheet

summarizes the financial position of the bank Asset/ liability /owner equity

The less progressive the tax system

the less stable the economy

The more progressive the tax system

the more stable the economy because the greater the economy's built in stability the larger cyclical deficits and surpluses MPC becomes smaller and multiplier becomes smaller

Bank assets

uses of funds