Macroeconomics Section 6: Modules 30-36
who led the movement called *monetarism* that sought to eliminate macroeconomic policy activism while maintaining the importance of monetary policy?
Milton Friedman
In the long run, changes in the quantity of money affect the aggregate price level but they (do/do not) change real aggregate output or the interest rate.
do not
Quantity Theory of Money
emphasizes the positive relationship between the price level and the money supply relies on the velocity equation ( M x V = P x Y)
Today most economists accept that the ______ ______ ________ - the rate of inflation that employers and workers expect in the near future - is the most important factor, other than the unemployment rate, affecting inflation.
expected inflation rate
Keynesian economics
focuses on the ability of shifts in AD to influence aggregate output in the short run
public debt
govt. debt held by individuals and institutions outside the govt.
When expected inflation rate increases, the actual inflation rate will? When it decreases, the actual inflation rate will?
increase by the same amount; decrease by the same amount
expansionary fiscal policies
increased govt. purchases of goods and services, higher govt. transfers, or lower taxes - reduce the budget balance for a yr
In January 2012, Ben Bernanke (chair of the Fed) announced that the Fed would set policy to maintain an approx. 2% inflation rate per yr. The Fed joined a # of central banks that have explicit ______ __________.
inflation targets
cost-push inflation
inflation that is caused by a significant increase in the price of an input with economy-wide importance
demand-pull inflation
inflation that is caused by an increase in aggregate demand
A government that runs persistent _____ deficits will have a rising debt-GDP ratio when debt grows faster than GDP.
large
what curve shows that it is not possible to achieve lower unemployment in the *long run* by accepting higher inflation?
long-run Phillips curve
price stability
low (though usually not 0) inflation
what term appears to have been coined in 1933 by the Norwegian economist Ragnar Frisch?
macroeconomics
to avoid accelerating inflation over time, the unemployment rate must be high enough that the actual rate of inflation _____ the expected rate of inflation
matches
Thanks to Wesley Mitchell, the _______ of business cycles was well adavanced by 1930. But, there was no widely accepted _____ of business cycles.
measurement; theory
Friedman argued the central bank should follow the ______ _________ rule.
monetary policy
Milton Friedman and his co-author Anna Schwartz (A Monetary History) played a key role in convincing macroeconomists of the importance of what?
monetary policy (supply of money)
expansionary monetary policy
monetary policy that increases aggregate demand
contractionary monetary policy
monetary policy that reduces aggregate demand
What determines the interest rate in the short run? In the long run?
money market; loanable funds market
what is another name for the NAIRU?
natural rate of unemployment (the portion of the unemployment rate unaffected by business cycle swings)
in the view of many macroeconomists, does the rational expectations hypothesis accurately describe how the economy behaves?
no
inflation targeting
occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target
The Taylor rule adjusts monetary policy in response to ____ inflation while inflation targeting is based on a forecast of _____ inflation.
past; future
inflationary gaps
real GDP is above potential output
recessionary gaps
real GDP is below potential output
contractionary fiscal policies
reduced govt. purchases of goods and service, lower govt. transfers, or higher taxes - increase the budget balance for a yr
short-run Phillips curve (SRPC)
represents the negative short-run relationship between the unemployment rate and the inflation rate
political business cycle
results when politicians use macroeconomic policy to serve political ends
A decrease in AD leads to a ____ in the unemployment rate and ____ in the inflation rate.
rise; fall
the budget deficit almost always _____ when the unemployment rate rises and _____ when the unemployment rate falls
rises; falls
fiscal year
runs from Oct 1 to Sep 30 and is labeled according to the calender year in which it ends budget totals are kept with these
New Keynesian economics
says that market imperfections can lead to price stickiness for the economy as a whole provides an explanation against rational expectations hypothesis
long-run Phillips curve
shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience
Classical model of the price level
simplified model in which the real quantity of money (M/P) is always at its long-run equilibrium level useful to examine high inflation
dedicated taxes
special taxes on wages
implicit liabilities
spending promises made by govts that are effectively a debt despite the fact that they are not included in the usual debt statistics
what shifts the short-run aggregate supply curve and the Phillips curve?
supply shocks
Social Security trust fund
surplus in the Social Security system Social Security taking in more revenue than it needs to prepare for the retirement of the baby boomers
The Federal Reserve can move the interest rate through open market operations that shift the money supply curve. In practice, the Fed sets a _________ _________ ________ _________ and uses open-market operations to achieve that target.
target federal funds rate
business cycle effects on the budget balance are?
temporary
monetizes debt
the Fed creates money and buys the debt back from the public through open-market purchases of Treasury bills
government debt
the accumulation of past budget deficits - past budget surpluses
budget balance
the difference between the government's tax revenue and its spending, both on goods and services and on government transfers in a given year
debt-GDP ratio
the government's debt as a percentage of GDP used to assess the ability to pay debt
disinflation
the process of bringing down inflation that has become embedded in expectations
open market operations
the purchase or sale of Treasury bills
velocity of money
the ratio of nominal GDP to the money supply measure of the # of times the average dollar bill is spent per year
rightward shift of AD
demand-pull inflation
Fed's tools not used on a regular basis
discount window reserve requirements
largest implicit liabilities
1. Social Security 2. Medicare 3. Medicaid
what does a shift or increase in aggregate demand lead to?
1. inflation 2. fall in the unemployment rate shifts in AD lead to movements along the Phillips curve
why did new classical macroeconomics evolve?
1. rational expectations 2. real business cycle theory
rules for the relationship between unemployment rate and output gap
1. when actual aggregate output is = to potential output, the actual unemployment rate = natural rate of unemployment 2. when the output gap is + (an inflationary gap), the unemployment rate is below the natural rate. when the output gap is - (a recessionary gap), the unemployment rate is above the natural rate
Taylor rule for monetary policy equation
Federal Funds Rate = 1 + (1.5 x inflation rate) + (0.5 x output gap)
The debt-GDP ratio can fall, even when the debt is rising as long as?
GDP grows faster than debt
Zero interest rate policy (ZIRP)
Japan's equivalent of the federal funds rate set as equal to 0 (during deflation)
In 1936, who presented his analysis of the Great Depression in a book called "The General Theory of Employment, Interest, and Money?"
John Maynard Keynes
velocity equation
M x V = P x Y where M is the money supply V is velocity P is aggregate price level and Y is real GDP
deflation
a falling aggregate price lvl common before WWII
what concept shows the short-run trade-off between unemployment and inflation?
Phillips curve
formula for the budget balance (savings by the govt.)
Sgovernment = T - G - TR T= value of tax revenues G = government purchases of goods and services TR = value of government transfers
monetary policy rule
a formula that determines the central bank's actions and leaves little discretion slow and steady growth in the money supply
inflation tax
a reduction in the value of money held by the public caused by inflation
Taylor rule for monetary policy
a rule for setting the federal funds rate that takes into account both the inflation rate and the output gap
liquidity trap
a situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound
a persistent attempt to trade off lower unemployment for higher inflation leads to ___ inflation over time.
accelerating
new classical macroeconomics
an approaach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output
cyclically adjusted budget balance
an estimate of what the budget balance would be if real GDP were exactly equal to potential output no inflationary or recessionary gap!
monetarism
asserts that GDP will grow steadily if the money supply grows steadily
Friedman's solution was to put monetary policy on ?
autopilot
baby boom (1946-1964)
baby boomers beginning to retire. as more of them do, they will stop earning income and start collecting benefits. the ratio of retirees receiving benefits to workers paying into the Social Security system is increasing
Keyes argued that factors like changes in animal spirits - these days referred to as ________ - are mainly responsible for business cycles.
business confidence
monetary neutrality
changes in the money supply have no real effects on the economy ?
leftward shift of AS
cost-push inflation
2 possible changes that lead to an increase in the aggregate price level
decrease in aggregate supply increase in aggregate demand
In the short run, an increase in the money supply leads to a _____ in interest rates, and a decreases in money supply leads to a ____ in interest rates. In the long run, changes in the money supply don't affect the interest rates at all.
decrease; increase
debt deflation
the reduction in AD arising from the increase in the real burden of outstanding debt caused by deflation (may lead to further deflation in vicious cycle like in the Great Depression)
natural rate hypothesis
the relationship between accelerating inflation and the unemployment rate
seignorage
the revenue generated by the govt.'s right to print money
what do inflationary expectations shift?
the short-run AS curve and the short-run Phillips curve
nonaccelerating inflation rate of unemployment (NAIRU)
the unemployment rate at which inflation does not change over time
discretionary monetary policy
the use of changes in the interest rate or the money supply by the central bank to stabilize the economy monetarists believe it faces the same lag problems as fiscal policy but to a lesser extent
macroeconomic policy activism
the use of monetary and fiscal policy to smooth out the business cycle legitimized by Keynes
Rational expectations (John Muth in 1961)
the view that individuals and firms make decisions optimally, using all avaliable information
natural rate hypothesis
to avoid accelerating inflation over time, the unemployment rate must be high enough that the actual inflation rate = the expected inflation rate
Advocates of inflation targeting argue it has what 2 key advantages?
transparency (public knows the objective) accountability (can judge how close actual inflation rates match the inflation target)
a negative supply shock shifts SRPC __ a positive supply shock shifts SRPC ____
up; down
the long-run Phillips curve is what kind of line?
vertical
when can a liquidity trap occur?
when there is a sharp reduction in demand for loanable funds (like in the Great Depression)
who are the winners and losers of deflation?
winners - lenders losers - borrowers
see 35.1
yes
see figure 31.3
yes
see figure 32.1 and 32.2
yes
see figure 34.6
yes
see figure 34.7 on the Fisher Effect
yes
There is a ____ _____ on the nominal interest rate; it cannot go below _.
zero bound; 0
from 2008 to 2014, the Fed found itself against the ___ ____ in the aftermath of the housing bubble collapse and the ensuing financial crisis. The interest on short-term US govt. debt fell to _.
zero bound; 0
