Economics Final

If the Fed Increases the IORB rate

If the Fed INCREASES the IORB rate

• Banks will earn more on reserve balances, which incentivizes them to pull money from the

economy.

• This also raises the federal funds rate, and thus also market interest rates, making it more

expensive to borrow money = ↓Consumption C, & ↓Investment I

➢Decreases Money Supply

➢Slows economic activity, and possibly cools inflation

If the Fed Decreases the IORB rate

Banks will earn less on reserve balances, which incentivizes them to pull money from the

FED.

• This also lowers the federal funds rate, and thus also market interest rates, making it

cheaper to borrow money = ↑Consumption C, & ↑Investment I

➢Increases Money Supply

➢Stimulates economic activity, and possibly increases employment

If Fed Increases the Reserve Requirement

If Fed INCREASES the Reserve Requirement

• Banks can loan out LESS money = ↓Consumption C, & ↓Investment I

➢Decreases Money Supply

➢Slows economic activity, and possibly cools inflation

If Fed Decreases the Reserve Requirement

Banks can loan out MORE money = ↑Consumption C, & ↑Investment I

➢Increases Money Supply

➢Induces economic activity, and possibly grows GDP and

employment (but risks inflation)

If Fed Increases the Discount Rate

Encourages Saving

➢Discourages loans, thus less borrowing (↓Consumption C, & ↓Investment I)

➢Decreases Money Supply

If Fed Decreases the Discount Rate

Discourages Saving

➢Encourages loans, thus more borrowing (↑Consumption C, & ↑Investment I)

➢Increases Money Supply

If the Fed Sells Bonds

Fed hands out the Bond (an IOU paper), and receives money (pulls money out of circulation)

➢ Thus, individuals and banks have less Money, thus less consumption ↓ C, and less loans & investment ↓ I

➢Decreases Money Supply

If the Fed Buys Bonds

Fed receives the Bond (the IOU paper), and releases money (puts money into circulation)

➢ Thus, individuals and banks have more Money, thus more consumption ↑ C, and more loans & investment ↑ I

➢Increases Money Supply

2 fiscal policy tools

taxes, government spending

GDP

the total value of goods and services produced in a year.

C + I + G + NX

National Income (aka Aggregate Demand)

C → Consumer Spending

I → Investment (Business Spending)

G → Government Spending

NX → Net Exports (Exports – Imports)

Expansionary policy

When the Fed acts to stimulate economic spending

Contractionary policy

When the Fed acts to cool or contract economic spending

commodity

money like shells, beads, salt, rare rocks, silver, gold

fiat

paper money that fluctuates based on the government

Revaluation

When a government deliberately strengthens currency

devaluation

when government deliberately weakens currency

appreciation

When currency naturally strengthens due to free market forces of demand and supply

depreciation

when currency naturally strengthens due to free market forces of demand and supply.

Trade balance

Trade deficit

• Less exports < More imports → we want more of their currency

↑Trade deficit → ↓$ depreciates

Trade surplus

• More exports > Less imports → they want more of our currency

↑Trade surplus → ↑$ appreciates

➢ Note: this implies trade imbalances should be self-correcting!

Explanation

➢ If we want more of their currency, theirs gets stronger (appreciates), ours gets weaker (depreciates), & vice versa

Differences in inflation rates between countries

• When our inflation is relatively higher, our $ purchasing power is lower, foreigners may not want to hold $s.

• → They don’t really want our currency (our $ depreciates)

↑Inflation → ↓$ depreciation

Explanation

➢ If we want more of their currency, theirs gets stronger (appreciates), ours gets weaker (depreciates), & vice versa

Differences in Interest rates between countries

Relatively higher interest rates → attract foreign capital investment

• Thus, foreigners are more willing to own assets in $ → they want more of our currency (our $ appreciates)

↑interest rates → ↑$ appreciates

Public debt

A large debt encourages inflation (↑money supply), which means our $ purchasing power may gradually decrease

• Thus, foreigners are less willing to own assets in $ → they want less of our currency (our $ depreciates)

↑debt (↑Inflation) → ↓$ depreciation

Political/Economic Stability

More stable economy → more attractive place to invest

• Thus, foreigners are more willing to own assets in $ → they want more of our currency (our $ appreciates)

↑economic stability → ↑$ appreciates

Official reserve currency status

• Widely accepted international trade currency → they want more of our currency (US$)

↑Official Reserve → ↑$ appreciates

What may be the implication of this on the trade balance?

➢May contribute to trade deficits

• Less exports < More imports → we want more of their currency

↑Trade deficit → should lead to ↓$ depreciate (but does not)

➢ i.e.: this partially hinders the trade imbalance self-correcting mechanism!

absolute advantage vs comparative advantage

Absolute advantage is about producing more efficiently, while comparative advantage is about producing at a lower opportunity cost, guiding trade and specialization.

Federal Reserve’s dual mandate

The dual mandate directs the Federal Reserve to pursue two co-equal economic goals: maximum sustainable employment and price stability. Maximum employment refers to the highest level of employment the economy can sustain without triggering inflationary pressures, rather than a literal zero unemployment rate, and is influenced by nonmonetary factors such as labor market structure and demographics. Price stability means keeping inflation low and stable over time, with the Fed targeting an average of 2 percent annual inflation as measured by the personal consumption expenditures (PCE) price index.

Inflation and deflation

supply and demand

types of government

Banking and Money Creation

fractional reserve banking

money multiplier

required reserve ratio

keynes on positions on stimulus

keynes on positions on business cycles

keynes on position on government role

hayek position on stimulus

hayek position on business cycles

hayek position on government role

National Income Accounting (GDP and relative size of components)

trade balance

comparative advantage

benefits/costs of trade

arguments against free trade

Economic Stimulus keynesian argument

Economic Stimulus Austrian argument

Four factors of production