Econ exam #2

19, 21, 22, 28, 30, 33 & 34

inflation

general, ongoing rise in the level of prices across the economy

hyperinflation

extreme case in which prices increase at astronomical rates

Zimbabwe 2008

example of hyperinflation

substitution bias

if you only calculate inflation using a fixed basket of goods you ignore the fact that people can buy cheaper goods as their purchasing power gets worse

quality/new goods bias

if you only calculate inflation using a fixed basket of goods you ignore that goods can get better in quality or new goods can be invented

overstate

An inflation rate calculated using a fixed basket of goods tends to ______ the true rise in the cost of living.

housing (42.4%)

highest rated category to create CPI

core inflation index

takes CPI and exudes volatile economic variables like energy and food prices

helps actually see price changes that affect cost of living without owing price changes to already volatile markets

why does the CII help?

government policy changes

what changes are made using the CII?

only ~0.5% per year

how much does the CPI overestimate inflation by?

updates basket of goods frequently; using different math methods to calculate CPI

how does the BLS compensate for biases in the basket of goods?

producer price index (PPI)

measures inflation based on how much producers pay to make goods and services

International price index

measures inflation based on exported and imported goods

employment cost index

measures inflation based on how much workers are paid

GDP deflator

measures inflation based on all GDP component prices (consumption, investment, gov’t, exports minus imports)

after WW1, after WW2, 1970s

when were the most notable waves of inflation in the US?

deflation

severe negative inflation, where most prices in the economy are falling

following the 1920-21 recession, the Great Depression (1930s)

notable periods of deflation in the US

hyperinflation

an outburst of high inflation

when economies shift from controlled to market oriented

when does hyperinflation often occur?

in the Confederate states, 1860-65

when did the US get close to hyperinflation?

prices, wages, interest rates

economic variables that should adjust with inflation (if they don’t we have problems)

unintended redistributions of purchasing power, blurred price signals, difficulties in long-term planning

problems if prices/wages/interest rates don’t rise with inflation (or if they have a time lag to adjust)

people holding cash, investors where the nominal return doesn’t adjust for inflation, when wages don’t adjust for inflation, retirees with a fixed private company defined pension

What kind of people are hurt by inflation?

borrower paying a fixed interest rate (their rate is worth comparatively less as the years go by)

What kind of people benefit from inflation?

when we perceive price more vaguely we can’t react as well to economic signals

what’s the problem with blurred price signals?

indexed

a price, wage, or interest rate is adjusted automatically for inflation

cost-of-living adjustments (COLAs)

contractual provision that wage increases to keep up with inflation

adjustable-rate mortgage (ARM)

type of loan borrower uses to purchase a home in which the interest rate varies with market interest rates

COLAs, ARMs

examples of indexing arrangements in private markets

US income tax code, adjusting levels of Social Security benefits, indexed bonds

examples of indexing arrangements in government programs

central bank

organization that ensures a country’s financial system operates smoothly as well as conducting monetary policy

Federal Reserve

central bank of the US

semi-decentralized

structure of the Federal Reserve, in which some employees are appointed by the government and others are representatives from private banks

7 members appointed by President and confirmed by Senate

who runs the Federal Reserve?

Jerome H. Powell

current chair of Federal Reserve Board

controls agenda and is Fed’s public voice

what is the power of the Chair of the Federal Reserve Board?

San Francisco, Dallas, KC, Minneapolis, Chicago, St. Louis, Cleveland, Atlanta, Richmond, New York, Philly, Boston

where are the 12 Federal Reserve banks (DC is the 13th)?

conducting monetary policy, promoting financial system stability, providing banking services to gov’t and commercial banks

3 functions of Federal Reserve

solvency

the degree to which someone’s (usually a business) assets are greater than their liabilities

maintain bank solvency and avoid excess risk

what is bank regulation meant to do?

minimum net worth to protect depositors and other creditors

what does regulation require of a bank?

percentage of their assets

how is the bank’s minimum net worth usually expressed?

Office of Controller of the Currency, National Credit Union Administration (NCUA), Federal Reserve

gov’t agencies that monitor bank’s balance sheets to make sure their net worth is positive and risk isn’t too high

bank run

when depositors race to the bank to withdraw their deposits for fear that they’d otherwise be lost

deposit insurance

insurance system that makes sure depositors don’t lose money even if the bank goes bankrupt

Federal Deposit Insurance Corporation (FDIC)

who do banks pay a deposit insurance premium to?

lender of last resort

institution that provides short-term emergency loans in financial crisis conditions

conducting nation’s monetary policy

most important function of federal reserve

managing interest rates and credit conditions

what does monetary policy involve?

open market operations

the most common monetary policy tool in the US, when the central bank sells/buys Treasury bonds to influence quantity of money and interest rate levels

Federal Open Market Committee (FOMC)

who makes the decisions regarding open market operations?

7 members of Fed Reserve’s Board of Governors and 5 voting members from regional Federal Reserve Banks

who comprises the FOMC?

reserve requirement

percentage of each bank’s deposits that it’s legally required to hold either as cash in their vault or on deposit with the central bank

greater = less money available to lend out and vice versa

what does a change in the reserve requirement mean for a bank?

discount rate

interest rate charged by central bank on loans it gives to other commercial banks