Econ 211 exam 3 UNL

Expansionary Fiscal Policy

-increases government spending

-decreases taxes

-Aggregate demand INCREASES

Contractionary Fiscal Policy

-decreases government spending

-increases taxes

Aggregate demand DECREASE (opposite of Expansionary)

Nondiscretionary Fiscal Policy

passive, no action by policy makers, "automatic"

What creates built-in/automatic stability

nondiscretionary fiscal policy

budget Deficit

government spending > tax revenues in a year

budget surplus

government spending < tax revenues in a year

balanced budget

government spending = tax revenues

actual budget deficit

government spending > tax revenues in a year as % of GDP

Cyclical adjusted budget deficit

government spending > tax revenues in a year as % of potential GDP

Cyclically adjusted budget

what budget deficit would be if no cyclical changes in economy

Discretionary fiscal policy is expansionary if

it increases from year 1 to year 2

discretionary fiscal policy is contractionary if

it decreases from year 1 to year 2

How is public debt financed

-issuing & selling government securities (bonds and treasuries)

-they are debts

-in return government pays a fixed interest rate

Ownership of public debt

-foreign (34%)

-U.S. Banks (25%)

-Federal Reserve (15%)

-U.S. Government agencies (26%)

Burden on future generations

mixed; public debt = credit for debt holders

-if U.S. taxpayers pay more now, then the U.S. debt holders get more

how can U.S. reduce deficits and public debt

-Taxes: increase them, it reduces incentive to work, save and invest. reduces economic freedom as people have less income

-Expenditures: cute them. But it is hard to cut gov. programs, many are mandated

-postpone it: finance by borrowing money

Debt limit debate

legal limit treasury can borrow to pay gov bills

can the government spend more with a higher debt limit?

No, allows treasury to borrow more to pay gov bills that congress has approved

-no current debt limit

-total public debt = $20 trillion

-treasury needs to be authorized to borrow that amount

Will congress raise debt limit?

most likely, raising limit = more spending and more ability to treasury to authorize gov spending

Recognition lag

between start of recession and recognition that it is occurring

administrative lag

between recognition of problem and time legislation is passed

operational lag

between legislation passed and the fiscal policy has its effects

effects of politics and political changes on fiscal policy

creates uncertainty and less stability, may run counter to sound economics

political business cycle

more spending and more promises before elections

state policies

pro-cyclical (reinforces business cycle)

federal policy

counter-cyclical (works against business cycle)

net effect during a recession

state gov cut spending and federal gov increases spending

Tax changes are temporary

people will not change spending

tax changes permanent

people will change spending

crowding out effect

may increase interest rate because gov increases its borrowing

higher interest rates=

less investment

increase in gov spending=

increase AD

increase in interest rate=

decreases AD

Functions of money

-medium of exchange

-unit of account

-store of value

medium of exchange

money is valuable when users accept it in buying and selling goods and services

unit of account

money is like a yardstick - it can be used to compare the worth of things

store of account

money is a way of storing wealth

M1=

coin/paper money and checkable deposits

M2=

M1 + savings deposits including money market deposit accounts, small time deposits, money market mutual funds held by individuals

Why is money debt

federal reserve notes are debt of federal reserve banks, checkable deposits are debt of commercial banks

who manages debt from money

monetary authorities

inflation and purchasing power of money

-what a dollar will buy varies inversely with price

-higher price=less dollar will buy

value of dollar

=1/price level

high inflation reduces

purchasing power of money and acceptability of money

is a credit card the same as money

NO, short-term loan to a buyer from credit card company, loan will be paid off w/ checkable deposit

Structure of FED

-board of governors

-federal reserve banks

-federal open market committee

FED board of governors

-7 members with 14-year terms

-1 chair member with 4-year term

-members appointed by president and senate

FED Decentralized central bank

12 banks across nation for diversity

FED Quasi-Public banks

each bank is owned by private commercial banks in its region but have public control

FED Banker's Bank

perform same function as bankers do

Federal open market committee

-monetary policy making arm of FED

-typically meets 8 times a year

goals of monetary policy

-keep inflation low

-promote economic growth

-achieve full employment

parts of balance sheet

assets & liabilities and net worth

gaining property

adds to assets

bank accepts deposit

-no effect on money supply

-composition of the money supply changes

actual reserve

all reserves that the banks keep at FED

=required-excess

required reserve

% of checkable deposits banks are required by law to keep at FED

=actual-excess

-gives FED control

-fraction of checkable deposits

excess reserve

extra reserves at FED are not required

FED purpose

control bank lending

Depositing check against another bank

Bank #1 loses reserve & checkable deposits but no money has been created

Bank loan

loan=asset increase,

liability - checkable deposits increase

how do banks create money

-loan checkable deposits

-in return bank will receive IOU (asset)

Write a check on a loan

checkable deposits decrease

bank reserves decrease

buy government securities

checkable deposits increase, bank assets increase in form of securities

conflicting bank goals

-profit

-liquidity (safety)

-resolved in Federal Funds Market

liquidity

assets to meet depositor needs, reducing bank risk

Federal Funds Rate

interest rate paid on overnight loans of excess bank reserves

Bank makes a loan of its excess reserves

deposited at another bank