AP Macro - Unit 5: Long-Run Consequences

Monetary Policy, Long/Short Run Consequences

Fiscal policy

The use of government spending and taxation to influence the economy

Monetary policy

Primarily concerned with the management of interest rates and the total supply of money in circulation and is generally carried out by central banks (the Fed)

Reserve Ratio

How much $ banks must keep on hand

Discount Rate

Interest rate that the Fed charges to banks that borrow from the Fed

Bond

IOU to repay principal and interest. Fed gives these to people and earns money.

Tight money policy

• When combatting inflation

• Selling bonds

• Increasing reserve ratio

• Increase Discount rate

Easy money policy

• When combatting recession

• Buy bonds

• Decrease reserve ratio

• Lower discount rate

Policy/interest rate

The monetary charge for borrowing money

Short run

A period in which at least one variable remains fixed as the price level changes

QF

Full employment

Long run

A period in which all variables remain responsive to changes in the price level

Nominal wage

Money that is paid or received and not adjusted for inflation

Recession

• A recession is an extended period (usually two consecutive quarters) of significant decline in economic activity

• When Q is below Qf

Inflation

• A sustained increase in the overall price level in the economy, which reduces the purchasing power of a dollar

• When Qf is below Q

Price Level

The price or cost of a good, service, or security in the economy.

Loan

A sum of money that is expected to be paid back with interest

Phillips Curve

Inflation and unemployment have an inverse relationship

Money Market

Money Demand \ and Money Supply |

Loanable Funds

Supply and demand of loanable funds

Deficit

Spending > revenues

Crowding out

Deficits drive up interest rates and reduce investment. Caused by expansionary fiscal (spending) policy

Expansionary fiscal policy

Increase government spending, real interest rates increase, and taxes decrease. Essentially putting money to boost spending.

Expansionary monetary policy

EASY MONEY POLICY! (Buying bonds, lower interest rates for cheaper borrowing)

Contractionary fiscal policy

Decrease government spending, real interest rates decrease, taxes increase

Essentially putting money to discourage spending.

Contractionary monetary policy

TIGHT MONEY POLICY (Selling bonds, increase interest rates for more expensive borrowing)

Economic growth

Increase in real GDP per capita illustrated by outward shift of PPC and LRAS