Chap. 5 - Finance

What are the four national economic policy objectives?

Economic Growth, High Employment, Price Stability, and Balance in International Transactions.

What is GDP?

Gross Domestic Product; the output of goods and services in an economy.

What is inflation?

An increase in prices of goods and services not offset by an increase in quality.

What is real GDP?

GDP growth after accounting for inflation; reflects higher living standards.

What are the four major policy maker groups?

Federal Reserve System, President, Congress, and U.S. Treasury.

What is the Federal Reserve's primary responsibility?

Setting monetary policy.

What are the President and Congress primarily responsible for?

Setting fiscal policy.

What is the U.S. Treasury primarily responsible for?

Debt management policy.

What is fiscal policy?

Government actions involving taxation and spending to influence economic activity.

What are the three ways the government raises funds?

Taxes, borrowing, and printing money.

What was the "Perfect Financial Storm"?

The combination of the 2007-08 Financial Crisis and the 2008-09 Great Recession.

What contributed to the Perfect Financial Storm?

Falling housing prices, stock market declines, mortgage defaults, and weak financial institutions.

What was the Economic Stabilization Act of 2008?

A law allowing the Treasury to purchase troubled financial assets.

What was the American Recovery and Reinvestment Act of 2009?

A law designed to stimulate economic recovery through tax relief and government spending.

What is a government deficit?

When government spending exceeds tax revenue.

What is monetizing the debt?

When the Fed increases the money supply to help finance government deficits.

What are automatic stabilizers?

Ongoing government programs that help stabilize economic activity automatically.

What are examples of automatic stabilizers?

Unemployment insurance, welfare payments, and progressive income taxes.

What are transfer payments?

Government payments made without receiving current services in return.

What are examples of transfer payments?

Unemployment benefits and welfare benefits.

What is tax policy?

The setting of tax levels and tax structures to influence the economy.

What is deficit financing?

The method a government uses to finance spending when expenditures exceed revenues.

What is crowding out?

A reduction in private borrowing caused by government borrowing.

What is the national debt?

The total debt owed by a government.

What is debt management?

Treasury decisions regarding refinancing debt, issuing securities, and managing borrowing costs.

What is the fractional reserve system?

A banking system where only a fraction of deposits must be held as reserves.

What is a primary deposit?

A deposit that adds new reserves to a bank.

What is a derivative deposit?

A deposit created when loans made from excess reserves become new deposits elsewhere.

What is checkable deposit expansion?

The process by which loans create additional deposits throughout the banking system.

What is the formula for multiple deposit expansion?

Change in Checkable Deposits = Increase in Excess Reserves ÷ Required Reserve Ratio.

If excess reserves increase by $1,000 and the reserve ratio is 20%, how much can deposits increase?

$5,000.

What are bank reserves?

Vault cash plus deposits held at Federal Reserve Banks.

What are required reserves?

The minimum amount of reserves a bank must hold.

What are excess reserves?

Reserves above the required minimum.

What are deficit reserves?

The amount by which required reserves exceed actual reserves.

What three groups affect bank reserves?

Nonbank Public, Federal Reserve System, and U.S. Treasury.

How can the nonbank public affect bank reserves?

By changing the amount of currency held outside the banking system.

What is cash leakage?

Currency held by the public outside the banking system.

What is a currency withdrawal?

When deposits are converted into cash and removed from banks.

How can the Federal Reserve affect bank reserves?

Through reserve requirements, open-market operations, bank borrowing, float, and other transactions.

How can the U.S. Treasury affect bank reserves?

Through Treasury spending and changes in Treasury cash holdings.

What is the monetary base (MB)?

Bank reserves plus currency held by the public.

What is the simple monetary base equation?

MB × m = M1.

What is the money multiplier (m)?

The factor by which reserves expand the money supply.

What is the simple money multiplier formula?

1 ÷ Reserve Ratio.

If the reserve ratio is 20%, what is the simple money multiplier?

5.

What is M1?

The basic definition of the money supply.

What is the complex money multiplier formula?

m = (1 + k) ÷ [r(1 + t + g) + k].

What does r represent in the money multiplier formula?

The reserve ratio.

What does k represent in the money multiplier formula?

The ratio of currency held by the public to checkable deposits.

What does t represent in the money multiplier formula?

The ratio of noncheckable deposits to checkable deposits.

What does g represent in the money multiplier formula?

The ratio of government deposits to checkable deposits.

What is velocity of money?

The rate at which money circulates through the economy.

Why is velocity of money important?

It links the money supply to GDP.

How is money supply linked to GDP?

Through velocity of money.

What is the growth-rate equation linking money supply and GDP?

M1 growth + Velocity growth = Real GDP growth + Inflation.

What is the formula for real GDP growth?

RGDP growth = M1 growth + Velocity growth − Inflation.

If M1 grows 4%, velocity grows 1%, and inflation is 3%, what is real GDP growth?

2%.

What was the Maastricht Treaty?

A 1991 agreement aimed at economic convergence and adoption of the euro.

What is the European Monetary Union (EMU)?

A group of European Union countries that adopted the euro.

What is the European Central Bank (ECB)?

The central bank responsible for maintaining price stability in euro-using countries.

What is the ECB's primary objective?

Price stability.

Which policy does each European Union member nation control independently?

Fiscal policy.

What happens when reserve requirements decrease?

The money supply can expand more.

What happens when reserve requirements increase?

The money supply expands less.

What happens to deposit expansion when excess reserves increase?

Deposit expansion increases.

What is the relationship between the money multiplier and reserve requirements?

They are inversely related.

Which policy maker group sets monetary policy?

The Federal Reserve System.

Which policy maker groups set fiscal policy?

The President and Congress.

Which policy maker group conducts debt management?

The U.S. Treasury.

What are the four economic goals policy makers try to achieve?

Economic growth, high employment, price stability, and balanced international transactions.