Fiscal and Monetary Policy Review

These flashcards cover key concepts from Chapters 7, 8, and 9 related to fiscal policy, monetary policy, and exchange rates.

What does fiscal policy refer to?

Government spending and taxation.

What does discretionary fiscal policy require?

New legislation.

What is a goal of fiscal policy?

Control inflation.

What is a fiscal policy tool?

Government spending.

When is expansionary fiscal policy used?

During a recession.

What does expansionary policy involve?

Increasing spending.

What happens when taxes are cut during a recession?

Increase AD.

What does the multiplier effect mean?

Initial spending has a larger total impact.

What happens when government spending increases?

AD shifts right.

What is the purpose of contractionary fiscal policy?

Reduce inflation.

What does contractionary policy include?

Raising taxes.

What happens to AD when government cuts spending?

AD decreases.

What is the crowding-out effect?

Government borrowing raises interest rates.

What do higher interest rates reduce?

All above (Consumption, Investment, Government spending).

What does Ricardian equivalence suggest?

People save tax cuts.

What does the permanent income hypothesis state?

People spend based on long-term income.

What does recognition lag refer to?

Delay in identifying a problem.

What is action lag?

Time to pass legislation.

What is effect lag?

Time for policy to impact economy.

What are automatic stabilizers?

Work instantly.

What do automatic stabilizers do during a recession?

Increase government spending.

What is a budget deficit?

Flow variable.

What is public debt?

Total accumulated borrowing.

When does a deficit occur?

Spending > Revenue.

How does the government finance deficits?

Selling bonds.

What are interest payments on debt?

Opportunity cost.

What causes foreign-held debt?

Economic leakage.

What is the long-term effect of high debt?

Reduced private investment.

How can the government reduce the deficit?

Raising taxes or cutting spending.

What does mandatory spending include?

Social Security.

What does a recessionary gap mean?

GDP below potential.

What is the aim of expansionary fiscal policy?

Increase output.

What may contractionary policy cause?

Recession risk.

What do automatic stabilizers include?

Unemployment benefits.

What is the main problem with barter?

Double coincidence of wants.

How is money defined?

Anything widely accepted as payment.

Which is NOT a function of money?

Tool of fiscal policy.

What is money used to buy goods called?

Medium of exchange.

What does money as a unit of account mean?

Measuring value.

Which function allows money to be saved?

Store of value.

What is a characteristic of good money?

Portability.

Fiat money has value because?

Government declares it legal tender.

What does commodity money have?

Intrinsic value.

Which is the most liquid asset?

Cash.

What does liquidity mean?

Ease of conversion to cash.

What is the opportunity cost of holding money?

Lost interest.

What does direct finance mean?

Borrowers and lenders interact directly.

What does indirect finance involve?

A financial intermediary.

How do banks create money?

Lending deposits.

What does the federal funds rate affect?

Borrowing costs across the economy.

What is fractional reserve banking?

Banks keep a fraction and lend the rest.

What are reserves?

Funds held by banks.

What is the central bank of the U.S.?

Federal Reserve.

What does FDIC insurance increase?

Trust in banks.

What is the FOMC responsible for?

Monetary policy decisions.

What does the money supply include?

Cash and deposits.

What is included in M1?

Cash and checking deposits.

What does expansionary monetary policy do?

Increases money supply.

What does contractionary monetary policy do?

Raises interest rates.

When the Fed buys bonds, what happens to the money supply?

Increases.

What happens when the Fed sells bonds?

Money supply decreases.

What occurs during a bank run?

Many depositors withdraw money at once.

Which of the following is included in M2 but NOT in M1?

Savings accounts.

How does the Federal Reserve influence the economy?

Through monetary policy.

What is the discount rate?

Rate the Fed charges banks.

What encourages banks to hold reserves?

Interest on reserve balances.

What causes a bank run?

People lose confidence in banks.

What is the lender of last resort function?

Fed lends to banks in crisis.

What is an exchange rate?

Price of one currency in terms of another.

What is the foreign exchange (Forex) market?

Where currencies are traded.

What does dollarization mean?

Adopting a foreign currency.

What is official dollarization?

Complete replacement of domestic currency.

What occurs during unofficial dollarization?

People use foreign currency informally.

What creates demand for a currency?

Foreign buyers.

What creates supply for a currency?

Domestic residents.

What happens if foreigners want U.S. goods?

Demand for USD increases.

What does currency appreciation mean?

Currency gains value.

What does currency depreciation mean?

Currency loses value.

What happens when a currency appreciates?

Imports become cheaper.

What happens when a currency depreciates?

Exports become cheaper.

Who benefits from a strong currency?

Importers.

Who benefits from a weak currency?

Exporters.

What does a weak currency make imports?

More expensive.

What is the most important short-run driver of exchange rates?

Interest rates.

What do higher interest rates in a country do?

Attract foreign capital.

What happens to the USD if U.S. interest rates rise?

USD appreciates.

What do expectations about future currency value do?

Can affect exchange rates immediately.

What do people do if they expect a currency to rise?

They buy it now.

What happens when a country has high inflation?

Currency depreciates/Weak currency.

What does appreciation of currency tend to do?

Reduce net exports.

What does depreciation of currency tend to do?

Increase net exports.

Why do governments care about exchange rates?

Inflation, exports, and stability.

What happens when a central bank buys its own currency?

Demand increases.

How are floating exchange rates determined?

Supply and demand.

What does a fixed (peg) exchange rate mean?

Government sets a fixed value.

What are tariffs?

Taxes on imports.

What is a major cost of protectionism?

Higher prices.

What happens if Americans buy foreign goods?

Supply of USD rises.

What does a stronger dollar do to exports?

Makes them more expensive.

What does a weaker currency lead to?

Higher exports.