Exam 5

interest-earning accounts that pool depositors' funds and invest them in highly liquid short-term securities. because these securities can be quickly converted to cash, depositors are permitted to write checks (which reduce their share holdings) against their accounts.

money market mutual funds

the concept that an increase in spending on a project will generate income for the resource suppliers, who will then increase their consumption spending. in turn, their additional consumption will generate income for others and lead to still more consumption. as this process goes through successive rounds, total income will expand by a multiple of the initial increase in spending

multiplier principle

the sum of the indebtedness of the federal government in the form of outstanding interest-earning bonds. it reflects the cumulative impact of budget deficits and surpluses

national debt

financial institutions that offer a wide range of services (for example, checking accounts, savings accounts, and loans) to their customers. commercial baks are owned by stockholders and seek to operate at a profit

commercial banks

a policy that tends to move the economy in an opposite direction from the forces of the business cycle. such a policy would stimulate demand during the contraction phase of the business cycle and restrain demand during the expansion phase

countercyclical policy

funds acquired by borrowing

credit

financial cooperative organizations of individuals with a common affiliation (such as an employer or a labor union). they accept deposits, including checkable deposits, pay interest (or dividends) on them out of earnings, and lend funds primarily to members

credit unions

MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the output of goods and services produced in an economy

equation of exchange

actual reserves that exceed the legal requirement

excess reserves

an increase in government expenditures and/or a reduction in tax rates, such that the expected size of the budget deficit expands

expansionary fiscal policy

a shift in monetary policy designed to stimulate aggregate demand. injection of additional bank reserves, lower short-term interest rates, and acceleration in the growth rate of the money supply are indicators of a more expansionary monetary policy

expansionary monetary policy

the ratio of the change in equilibrium output to the independent change in investment, consumption, or government spending that brings about the change. numerically, the multiplier is equal to 1 divided by (1-MPC) when the price level is constant

expenditure multiplier

a loanable funds market in which banks seeking additional reserves borrow short-term funds (generally for seven days or less) from banks with excess reserves. the interest rate in this market is called he federal funds rate

federal funds market

money that has neither intrinsic value nor the backing of a commodity with intrinsic value; paper currency is an example

fiat money

a system that permits banks to hold reserves of less than 100 percent against their deposits

fractional reserve banking

the time period after a policy change is implemented but before the change begins to exert its primary effects

impact lag

an index of economic variables that historically has tended to turn down prior to the beginning of a recession and turn up prior to the beginning of a business expansion

index of leading indicators

an asset that can be easily and quickly converted to money without loss of value

liquid

additional current consumption divided by additional current disposable income

marginal propensity to consume (MPC)

Before the Great Depression of the 1930s, most economists believed that: markets adjust and can direct an economy back to its long-run potential output. unemployment is directly related to the rate of inflation in an economy. fiscal policy alone can direct an economy to its long-run potential output. monetary policy alone can direct an economy to its long-run potential output.

markets adjust and can direct an economy back to its long-run potential output. Prior to the Great Depression, most economists thought that government intervention to restore GDP to its potential level was completely unnecessary.

an asset that is used to buy and sell goods or services

medium of exchange

the sum of currency in circulation plus bank reserves (vault cash and reserves with the Fed). it reflects the purchases of financial assets and the extension fo loans by the Fed

monetary base

the interest rate of the Federal Reserve charges banking institutions for short-term loans

discount rate

a change, in laws or appropriate levels, that alters government revenues and/or expenditures

discretionary fiscal policy

Suppose an economy is producing below its potential output in the absence of government policy intervention. Which of the following is likely to direct the economy toward full-employment equilibrium? A fall in the marginal propensity to consume An increase in the cost of capital A reduction in real wages A decrease in business investment

A reduction in real wages

a federally chartered corporation that insures the deposits held by commercial banks, saving and loans, and credit unions

Federal Deposit Insurance Corporation (FDIC)

a committee of the Federal Reserve system that establishes Fed policy with the regard to the buying and selling of government securities--the primary mechanism used to control the money supply. it is composed of the seven members of the Board of Governors and the twelve district bank presidents of the Fed

Federal Open Market Committee (FOMC)

the central bank of the US; it carries out banking regulatory policies and is responsible for the conduct of monetary policy

Federal Reserve System

the sum of (1) currency in circulation (including coins), (2) checkable deposits maintained in depository institutions, and (3) traveler's checks

M1

equal to M1 plus (1) savings deposits, (2) time deposits (accounts of less than $100,000) held in depository institutions, and (3) money market mutual fund shares

M2

a curve that illustrates the relationship between the rate of inflation and the rate of unemployment

Phillips curve

the view that a tax reduction financed with government debt will exert no effect on current consumption and aggregate demand because people will fully recognize the higher future taxes implied by the additional debt

Ricardian equivalence

built-in features that tend automatically to promote a budget deficit during a recession and a budget surplus during an inflationary boom, even without a change in policy

automatic stabilizers

the time period after the need for a policy change is recognized but before the policy is actually implemented

administrative lag

2. Although the economy was in the Great Depression, the Hoover administration followed a fiscal policy of balancing the budget. A Keynesian would have found this policy a. inappropriate because it probably would have depressed economic activity and led to further increases in unemployment. b. appropriate because it probably would have led to a significant increase in the money supply and thereby increased employment. c. inappropriate because it probably would have impaired the ability of monetary policy to end the Depression. d. appropriate because it probably would have stimulated economic activity and helped end the Depression.

a. inappropriate because it probably would have depressed economic activity and led to further increases in unemployment.

If an economy is operating below its potential capacity in the short run, an expansionary fiscal policy will shift the: short-run aggregate supply curve to the right. aggregate demand curve to the left. long-run-aggregate supply curve to the left. aggregate demand curve to the right.

aggregate demand curve to the right.

A budget surplus: allows the government to reduce its outstanding debt. increases the total fiscal debt of a country. reduces aggregate demand in an economy. equals the excess of government spending over total revenue.

allows the government to reduce its outstanding debt.

The consumption function shows the relationship between: a.planned consumption expenditures and disposable income. b.permanent income and savings. c.business inventory and real GDP. d.aggregate demand and aggregate consumption.

a.planned consumption expenditures and disposable income.

economists who believe that discretionary changes in monetary and fiscal policy can reduce the degree of instability in output and employment

activists

the hypothesis that economic decision-makers base their future expectations on actual outcomes observed during recent periods. for example, according to this view, the rate of inflation actually experienced during the past two or three years would be the major determinant of the rate of inflation expected for the next year

adaptive-expectations hypothesis

4. According to the Keynesian view, which of the following would most likely decrease aggregate demand? a. a decrease in tax rates b. a decrease in government expenditures c. an increase in transfer payments d. an increase in the budget deficit

b. a decrease in government expenditures

1. In a single year, a $5 billion tax reduction was accompanied by a $9 billion increase in consumer spending. From a Keynesian view, the most probable explanation for the increase in consumer spending by more than the amount of the tax cut is that a. lower taxes caused government spending to fall, which led to the increase in consumer spending. b. increased consumption spending by those with higher disposable incomes led to higher incomes and still more consumption spending by others. c. the tax cut caused interest rates to fall, thus increasing consumer spending. d. the lower taxes prompted the Federal Reserve to sell U.S. securities, causing both the money supply and consumer spending to increase.

b. increased consumption spending by those with higher disposable incomes led to higher incomes and still more consumption spending by others.

6. Keynesian analysis implies that a planned budget deficit is a. always necessary to ensure full employment. b. proper during slack economic conditions but highly inappropriate if the economy is already operating at capacity. c. of little consequence unless there is a corresponding change in the money supply. d. an effective method of dealing with inflation.

b. proper during slack economic conditions but highly inappropriate if the economy is already operating at capacity.

a situation in which current government revenue from taxes, fees, and other sources is just equal to current government expenditures

balanced budget

vault cash plus deposits of banks with Federal Reserve banks

bank reserves

a situation in which total government spending exceeds total government revenue during a specific time period, usually one year

budget deficit

a situation in which total government spending is less than the total government revenue during a time period, usually a year

budget surplus

3. Suppose U.S. policy makers decide that to stimulate GDP growth, investment must be increased. What is needed, they conclude, is a reallocation of resources away from producing consumer goods and toward producing capital goods. Which of the following policy alternatives would most likely accomplish this objective? a. a reduction in personal income taxes b. a reduction in state sales taxes c. a tax credit allowance for business investment in capital equipment d. restrictive monetary policy

c. a tax credit allowance for business investment in capital equipment

7. The crowding-out effect suggests that a. expansionary fiscal policy causes inflation. b. restrictive fiscal policy is an effective weapon against inflation. c. reduction in private spending resulting from the higher interest rates caused by a budget deficit will largely offset the expansionary impact of a pure fiscal action. d. a budget surplus will cause the private demand for loanable funds, the interest rate, and aggregate demand to fall.

c. reduction in private spending resulting from the higher interest rates caused by a budget deficit will largely offset the expansionary impact of a pure fiscal action.

Which of the following would most likely cause an increase in aggregate demand? a.An increase in the corporate income tax. b.An increase in interest rates. c.An increase in the budget deficit. d.An increase in personal income tax rates.

c.An increase in the budget deficit.

Keynesian analysis implies that potential output and price stability can be achieved if: a.the federal budget is balanced annually. b.marginal tax rates are kept low so the incentive to produce will be strong. c.aggregate demand is equal to the economy's full-employment rate of output. d.current saving exceeds the level of investment.

c.aggregate demand is equal to the economy's full-employment rate of output.

If the federal government is running a budget deficit: a.the national debt will decline. b.it will have to either raise taxes or reduce expenditures next year. c.the U.S. Treasury will finance the deficit by issuing additional bonds. d.the supply of money will increase and the general level of prices will rise.

c.the U.S. Treasury will finance the deficit by issuing additional bonds.

If fiscal policy is going to exert a stabilizing impact on the economy, it must be: a.instituted by the Federal Reserve system. b.expansionary during an economic boom but restrictive during a recession. c.timed correctly. d.passed by a three-fifths majority in Congress.

c.timed correctly.

an institution that regulates the banking system and controls the money supply

central bank

a reduction in private spending as a result of higher interest rates generated by budget deficits that are financed by borrowing in the private loanable funds market

crowding-out effect

medium of exchange made of metal or paper

currency

5. Which of the following is an example of an automatic stabilizer? a. Congress legislates lower tax rates to increase consumption and investment. b. Tax rates are increased during a recession to maintain a balanced budget. c. A regressive income tax system reduces tax revenues (as a share of income) as income expands. d. Revenues from the corporate income tax increase sharply during a business boom but decline substantially during a recession, even though no new tax legislation is enacted.

d. Revenues from the corporate income tax increase sharply during a business boom but decline substantially during a recession, even though no new tax legislation is enacted.

8. Other things constant, an increase in marginal tax rates will: a. decrease the supply of labor and reduce its productive efficiency. b. decrease the supply of capital and reduce its productive efficiency. c. encourage individuals to substitute less desired, tax-deductible goods for more desired, non-deductible goods. d. cause all of the above.

d. cause all of the above.

10. A balanced budget is present when a. the economy is at full employment. b. the actual level of aggregate spending equals the planned level of spending. c. public sector spending equals private sector spending. d. government revenues equal expenditures.

d. government revenues equal expenditures.

9. The new classical model implies that substitution of debt for tax financing a. increases aggregate demand and exerts a multiplier effect leading to an expansion in real output. b. is highly effective against inflation. c. reduces consumption because it increases both the current and future tax liability of households. d. leaves wealth and therefore aggregate demand unchanged since the debt implies higher future taxes.

d. leaves wealth and therefore aggregate demand unchanged since the debt implies higher future taxes.

The marginal propensity to consume (MPC) is: a.consumption expenditures divided by saving. b.consumption expenditures divided by disposable income. c.consumption expenditures divided by personal income. d.additional consumption expenditures divided by additional disposable income.

d.additional consumption expenditures divided by additional disposable income.

An expansionary fiscal policy: leads to a balanced budget. decreases the volume of national debt. decreases aggregate demand in an economy. decreases the total unemployment in an economy.

decreases the total unemployment in an economy.

non-interest-earning checking deposits that can be either withdrawn or made payable on demand to a third party. like currency, these deposits are widely used as a means of payment

demand deposits

a curve that indicates the relationship between the interest rate and the quantity of money people want to hold. because higher interest rates increase the opportunity cost of holding money, the quantity of money demanded will be inversely related to the interest rate

demand for money

the multiple by which an increase in reserves will increase the money supply. it is inversely related to the required reserve ratio

deposit expansion multiplier

businesses that accept checking and savings deposits and use a portion of them to extend loans and make investments. banks, saving and loan associations, and credit unions are examples

depository institutions

economists who believe that there are strong forces pushing a market economy toward full-employment equilibrium and that macroeconomic policy is an ineffective tool with which to reduce economic instability

new classical economists

economists who believe that discretionary macro policy adjustments in response to cyclical conditions are likely to increase, rather than reduce, instability. nonactivists favor steady and predictable policies regardless of business conditions

nonactivists

the buying and selling of US government securities and other financial assets in the open market by the Federal Reserve

open market operations

interest-earning deposits that are also available for checking

other checkable deposits

the idea that when many households simultaneously try to increase their saving, actual saving may fail to increase because the reduction in consumption and aggregate demand will reduce income and employment

paradox of thrift

the maximum potential increase int eh money supply as a ratio of the new reserves injected into the banking system. it is equal to the inverse of the required reserve ratio

potential deposit expansion multiplier

the portion of the national debt owed to domestic and foreign investors. it does not include bonds held by agencies of the federal government or the Federal Reserve

privately held government debt

a theory that hypothesizes that a change in the money supply will cause a proportional change in the price level because velocity and real output are unaffected by the quantity of money

quantity theory of money

the hypothesis that economic decision-makers weigh all available evidence, including information concerning the probable effects of current and future economic policy, when they form their expectations about future economic event (such as the probable future inflation rate)

rational-expectations hypothesis

the time period after a policy change is needed form a stabilization standpoint bu before the need is recognized by policy-makers

recognition lag

the ratio of reserves relative to a specified liability category (for example, checkable deposits) that banks are required to maintain

required reserve ratio

the minimum amount of reserves that a bank is required by law to keep on hand to back up its deposits. if reserve requirements were 15%, banks would be required to keep $150,000 in reserves against each $1 million of deposits

required reserves

a reduction in government expenditures and/or an increase in tax rates such that the expected size of the budget deficit declines (or the budget surplus increases)

restrictive fiscal policy

a shift in monetary policy designed to reduce aggregate demand and put downward pressure on the general level of prices (or the rate of inflation). a reduction in bank reserve, higher short-term interest rates, and a reduction in the growth rate of the money supply are indicators of a more restrictive monetary policy

restrictive monetary policy

financial institutions that accept deposits in exchange for shares that pay dividends. historically, these funds were channeled into residential mortgage loans, but today they offer essentially the same services as a commercial bank

savings and loan institutions

an asset that will allow people to transfer purchasing power from one period to the next

store of value

economists who believe that changes in marginal tax rates exert important effects on aggregate supply

supply-side economists

a unit of measurement used by people to post prices and keep track of revenues and costs

unit of account

the average number of times a dollar is used to purchase final goods and services during a year. it is equal to GDP divided by the stock of money

velocity of money

Keynes believed that: interest rates are positively related to the total investment expenditure in an economy. wages and prices are highly inflexible, particularly in a downward direction. inflation and unemployment are positively related to each other. wages and prices adjust themselves to close an expansionary or contractionary gap.

wages and prices are highly inflexible, particularly in a downward direction. Keynes believed that spending motivated firms to supply goods and services. Less spending would lead to less output. Keynes rejected the view that lower wages and interest rates would get the economy back on track and eliminate abnormally high rates of unemployment.