Understanding Business Cycles and Monetary Policy

Economy

Although the economy can fluctuate, the overall trend is: up.

Long run economy trend

Although the economy can fluctuate, it tends to grow over the long run.

Business cycles

Business cycles are extremely complex.

Types of business cycles

Industry and product.

Factors causing economy fluctuation

Technology companies issuing new products and retiring old ones.

Leading indicators

Statistics that have been identified as having proven in the past to indicate possible future changes in the Gross National Product (GNP) and Gross Domestic Product (GDP).

Measure of inflation in the U.S.

The Consumer Price Index (CPI).

Normal inflation rate

Inflation of 1-3 percent per year is normal and common in healthy (expanding) economies.

Healthy unemployment rate

Most economists believe that an unemployment rate of 2-5 percent is the sign of a healthy or full-employment economy.

Government actions on unemployment

Tax rebates.

Government policies to minimize business cycle effects

Fiscal and monetary.

Federal Reserve monetary policy actions

Changing the tax rate.

Monetary policy for recession

Loose monetary.

Monetary policy for inflation

Tight monetary.

Business cycle

A business cycle is a series of expansion and contraction phases that a nation's economy experiences over time.

Variation in business cycles

The size and duration of the expansion and contraction phases vary tremendously.

Contraction phase

The cycle starts to decline; businesses reduce production and cut jobs, leading to a decrease in real GDP.

Peak phase

The maximum point of expansion; unemployment is low, production is high, and real GDP stops increasing.

Recovery (Expansion) phase

Economic activity rises; production and hiring increase, leading to economic growth (real GDP rises).

Trough phase

The lowest point of economic contraction; production and employment are at their worst, and real GDP stops decreasing.

Depression

Severe economic contraction with high unemployment and low production.

Inflation

A rise in prices leading to decreased purchasing power.

Recession

A decline in real GDP for at least two consecutive quarters.

Unemployment

When people who are able to work and actively seeking jobs cannot find employment.

Fiscal policy

Fiscal policies are measures used by governments to stabilize the economy, such as tax rate manipulation and government spending.

Disadvantage of fiscal policies

Any one of the following: Time lags, Contradictory goals, Threat of inflation.

Monetary policy

Monetary policies are measures such as manipulating money and credit supply to influence the economy.

Time lag

The delay between an economic action and its effects on the economy.

Loose monetary policy

A policy that aims to stimulate the economy by increasing the money supply.

Higher interest rates

Rates that restrict economic growth by making borrowing more expensive.

Deflationary tight monetary policies

Policies that can cause a recession by reducing the money supply.

Federal Reserve action for loose monetary policy

One action is to buy federal securities.

Federal Reserve action for loose monetary policy

Another action is to lower the reserve ratio.

Federal Reserve action for loose monetary policy

A third action is to lower the discount rate.

Federal Reserve action for tight monetary policy

One action is to sell federal securities.

Federal Reserve action for tight monetary policy

Another action is to raise the reserve ratio.

Federal Reserve action for tight monetary policy

A third action is to raise the discount rate.

Continental currency

Fiat paper money that was virtually worthless after the Revolutionary War.

Financial support for Congress

Both the Continental Congress and the Confederation Congress depended on France.

State money systems

Each state adopted a different money system during the Revolutionary War.

U.S. Congress power

The power to coin money was granted by the adoption of the U.S. Constitution.

Debts of the Continental Congress

Ultimately paid under a plan developed by Alexander Hamilton.

Bank charter

An agreement that establishes a bank and determines which government banking agencies will regulate it.

National bank

A commercial bank that has a charter issued by the federal government.

Central bank

A bank that provides banking services to its government and has a monopoly to issue currency for that government.

Bank reserves

The amount of money a bank should not lend out so that it is available if needed by depositors.

First Bank of the United States functions

To assist the state governments in tax collection and borrowing is NOT one of the four functions.

U.S. government ownership of the Bank of the United States

The U.S. government owned only 20% of the Bank of the United States.

Andrew Jackson

He vetoed the renewal of the charter of the second Bank of the United States.

Financial chaos causes (1833-1863)

Crop failures, economic mismanagement, and land speculation.

Bank run

When a bank's customers make sudden demands to withdraw their money on deposit.

Panic

A sudden widespread fear about the financial status of a bank, state, region, or country.

Federalist

A person who favored the ratification of the U.S. Constitution and wanted a strong central government.

Federalist banking system

A centralized banking system regulated by the federal government.

Alexander Hamilton

He led the Federalists on monetary policy.

Anti-Federalist

A person who opposed the ratification of the U.S. Constitution and favored strong individual rights.

Anti-Federalist banking system

A decentralized banking system regulated by individual states.

Negative consequences of the first Bank of the United States

State banks could not fully meet the needs of the federal government. It was difficult to finance the War of 1812 without a central bank.

How did Andrew Jackson cripple the second Bank of the United States?

He withdrew all federal funds from the Bank.

Nation's economy after 1833

There were wide swings between economic booms and financial chaos.

First authorization for printing money

Printing of federal paper money.

Greenbacks

Technically representative money because they were based on gold.

Legal Tender Act of 1862

Authorized the U.S. government to print a new currency called United States notes.

Fiat currency

Currency that is not backed by a physical commodity.

Reason for National Currency Act of 1863

People grew distrustful of the greenbacks.

National Currency Act of 1863

Created the National Banking System.

Backing of National Bank notes

U.S. government bonds that the banks owned.

Coinage Act of 1873

Stated that the federal government would no longer purchase silver for its reserves or mint silver coins.

Economic conservatives

Were (and are) very enthusiastic about the gold standard.

Prevailing international standard until the Great Depression

The gold standard.

Effect of Coinage Act of 1873

The supply of money in the U.S. to drop, and prices fell.

Panic of 1873

Sparked when a company failed because it was unable to raise money to build a second transcontinental railroad.

U.S. politics after Panic of 1873

Periodically dominated by debates on monetary policy.

U.S. government standard after Panic of 1873

Gold standard.

1896 presidential election candidates

William Jennings Bryan supported the use of silver; William McKinley supported the gold standard.

Bankers' urge after Panic of 1907

Urged Congress to create a central bank that could help sound banks meet the demands of their depositors during a bank run.

Entitlement to be a national bank under the National Banking System

A federal charter.

Gold standard

A monetary system using representative money in which the currency is tied to gold at a fixed rate of exchange.

First act putting the U.S. on the gold standard

Coinage Act of 1873.

Act again putting the U.S. on the gold standard

Gold Standard Act of 1900.

Advantage of the gold standard

It can discourage inflation, stabilize currency, and encourage trade.

Disadvantage of the gold standard

It limits economic growth and makes financial panics harder to control.

Event causing the economic depression of 1893

A panic over U.S. government gold reserves dropping too low.

Event threatening financial collapse in 1907

A failed attempt to 'corner the market' on a copper company led to a stock market and bank panic.