Macro Final Exam

Fiscal Policy:

The use of government's budget tools, government spending, and taxes to influence the macroeconomy (Legislated and approved by both congress and the president)

Expansionary policy:

Government increases spending or decreases taxes to stimulate or expand economy, (Leads to government deficits)

When the economy is slowing, the prescription is for

expansionary fiscal policy

What happens if we increase government spending

Will increase aggregate demand (shift right) since G is one component of AD and will increase GDP as well

What happens if we decrease taxes

Will raise disposable income and consumption which will also increase aggregate demand (shift right) and GDP

Contractionary policy:

Government decreases spending or increases taxes to slow economy

Purpose of contractionary policy

Pay off government debt, Keep economy from expanding, Beyond long-run capabilities

Automatic stabilizers:

Government programs that naturally implement countercyclical fiscal policy in response to economic conditions (Can eliminate recognition lags and implementation lags)

Examples of Automatic Stabilizers:

Progressive income tax rises, Corporate profit taxes, Unemployment compensation, Welfare programs

Crowding-out:

When private spending falls in response to increases in government spending// This reduces the ability of government spending to stimulate aggregate demand

Countercyclical fiscal policy:

Fiscal policy that seeks to counteract business cycle fluctuations//Expansionary policy during recessions//Contractionary policy during expansions

Multipliers:

The initial effects of fiscal policy can snowball over time

Marginal Propensity to Consume (MPC):

The portion of additional income spent of consumption

Equation for MPC\=

Change in consumption / change in income

T/F: MPC is constant across all people

False, MPC is NOT constant (0 < MPC < 1)

The Laffer Curve:

In region I, where tax rates are low, increases in tax rates increase tax revenue// In region II, where tax rates are high, increases in tax rates and decrease tax revenue

Time Lags:

Recognition lag, Implementation lag, Impact lag

Recognition lag:

It is difficult to determine when the economy is turning up or down

Implementation lag:

It takes time to implement fiscal policy

Impact lag:

It takes time for effects of policy to materialize

Supply-side Fiscal Policy:

The use of government spending and taxes to affect the production (supply) side of the economy (Target LRAS curve)

Factors that shift LRAS

Changes in resources, Technology, Institutions

They increase \________ for production activities

Incentives

Supply-side Initiatives:

R + D tax credit, Education policies (subsidies or tax benefits), Lower corporate profit tax rates, Lower marginal income tax rates

Money:

Any general accepted means of payment

Three functions of money

Medium of exchange, Unit of account, Store value

Medium of exchange:

What people trade goods and services (Most modern economies have a common medium of exchange provided by government)

Unit of account:

The measure in which parts prices are quoted//

Whats the purpose of unit of account

Creates a common language and unit of measurementEnables people to make accurate comparisons between items, Creates a consistent method of record keeping

Store of value:

A means for holding wealth

Examples of store of value:

Bank accounts, Savings accounts, Stocks, Bonds

Commodity money:

The use of an actual good for money (Historically the first medium of an exchange in an economy)

Commodity backed money:

Money you can exchange for a commodity at a fixed rate

M1:

The money supply measure composed of currency, and checkable deposits

What is included in M1?

Currency (Cash), Checking account, Travelers Checks

M2:

The money supply measure that includes everything in M1, plus savings deposits, money market mutual funds, and small-denomination time deposits (CDs)

Currency:

The paper bills and coins used to buy goods and services

Bank runs:

Occur when many depositors attempt to withdraw their funds at the same time

Barter:

Involves the trade of a good or service in the absence of a commonly accepted medium of exchange....Inefficient because it requires double coincidence of wants which is uncommon

Fiat money:

Money with no value except as the medium of exchange (No inherent or intrinsic value to the currency)

Assets:

The items a firm owns

Liabilities:

The financial obligations a firm owes to others

Balance sheet:

A financial journal that contains informations of assets, liabilities, and owners' equity

Double coincidence of wants:

Occurs when each party in an exchange transaction happens to have what the other party desires

Checkable deposits:

Deposits in bank account from which depositors may make withdrawals by writing checks

Owners' Equity:

The difference between a firm's assets and its liabilities (The sums of both sides of the balance sheet have to equal each other)

Fractional Reserve Banking:

When banks hold only a fraction of depositors on reserve

Reserves:

The portion of bank deposits that are set aside and not loaned out

Reserves include both \__________ in the banks vault and \_______ that the bank holds in deposits at it own bank, the Federal Reserve

Currency, Funds

Excess reserves:

Are any bank reserves held in excess of those required

Federal Reserve:

Central bank of the United States

What are the Federal Reserves three responsibilities?

Monetary policy, Central banking, Bank regulation

Required reserve ratio:

The portion of deposits that banks are required to keep on reserve

Required reserves \=

RR x Deposits

Discount loans:

Loans from the Fed to private banks

Discount rate:

The interest rate on the discount loans made form the Fed to private banks

Federal funds rate:

The interest rate on loans between private banks is called the federal funds rate

Moral hazard:

Lack of incentive to guard against risk

Open market operations:

The purchase or sale of bonds by a central bank

Buys securities —\>

Increase the money supply

Sells securities —-\>

Decrease the money supply

Quantitative easing:

The targeted use of open market operations in which the central bank buys securities specifically targeting certain markets

Simple money multiplier:

The rate at which banks \___COME BACK\________ money when all currency deposited into banks and they hold no excess reserves

Mm\=

1/rr

Simple money multiplier represents

maximum size of money multiplier

Monetary policy:

The federal reserve changes the money supply through open market operations

Open market operations involve the \___________ or \________ of bonds; normally, these are short-term treasury securities

Purchase,Sale

Contractionary monetary policy:

When a central bank takes action that reduces the money supply in the economy

Expansionary monetary policy:

When a central bank acts to increase the money supply in an effort to stimulate the economy

Active monetary policy:

The strategic use of monetary policy to counteract macroeconomic expansions and contractions (Assumes the Phillips curve relationship between inflation and unemployment holds in the long run)

Policy of Active monetary:

Inflate during downturns, Reduce inflation during booming economy

Implications of Active monetary:

With adaptive expectations— reduces unemployment in the short run, With rational expectations—potentially no gains

Monetary neutrality:

The idea that the money supply does not affect real economic variables (Because eventually all prices adjust, in the long-run monetary policy does not affect real GDP or unemployment)

Phillips curve:

Indicates a short-run negative relationship between inflation and unemployment rates

Two-part policy implication of Philips curve:

Less employment

In long-run of Phillips curve:

All prices adjust, No real effect from monetary policy, Long-run Phillips curve \= vertical line

Adaptive expectations:

Peoples expectations of future inflation are based on their most recent experience, (If expectations adapt, then monetary policy can stimulate the economy and reduce unemployment only if it is unexpected)

Rational expectations:

People form expectations on the basis of all available information('Forward-Looking')

Stagflation:

The combination of high unemployment and high inflation

Arbitrage:

Reservation Rate:

IORB Rate:

ONRRP Rate:

New Fed Tools:

Balance of payments:

Record of payments between a country and the rest of the world (A method to track payments made across borders)

Account deficit:

The growing economy leads to wealthier consumers who import more goods and services from around the world, meaning imports increase at a faster rate than exports

Account surplus:

Growing economies offer higher returns on investments, which attract international investment (Greater investment increases capital account surplus which reinforces a greater current account deficit)

Capital account:

Account that tracks payments for real and financial assets between nations and extensions of international loans which is often in a surplus (Inflows < Outflows)

Current account:

Account that tracks all payments for goods and services, current income from investments, and gifts which is often in a deficit (Inflows \> Outflows)

Currency appreciation:

When a currency becomes more valuable relative to other currencies (It takes less of that currency to buy other currencies & other currencies become cheaper)

Currency depreciation:

When a currency becomes less valuable relative to other currencies (It takes more of that currency to buy other currencies & other currencies become more expensive)

Derived demand:

Demand for a good or service that derives from the demand for another good or service

Exchange rate:

The price of foreign currency, indicating how much of a unit of foreign currency costs in terms of another currency

Exchange rates affect imports and exports and thus \_______

GDP

Exchange rate manipulation:

When a national government intentionally adjusts its money supply to affect the exchange rate of its currency

Why devalue your own currency?

Lowering the exchange rates makes exports more attractive and affordable it also boosts production by increasing aggregate demand (shift right) through increased exports (No long-term shift in LRAS, just higher inflation)

Flexible or floating exchange rate:

Exchange rates determined by the supply of and demand for currency

Pegged or fixed exchange rate:

Exchange rates fixed at a certain level through the actions of the government