MACRO EXAM 3

What is Fiscal Policy?

The use of government spending and tax policies to influence the economy.

What is Discretionary Fiscal Policy?

Deliberate changes in government spending or taxes to address economic conditions.

What is Fiscal Policy?

The use of government spending and tax policies to influence the economy.

What is Discretionary Fiscal Policy?

Deliberate changes in government spending or taxes to address economic conditions.

What are the tools of fiscal policy?

Tools:

1. Government Spending

2. Taxation

3. Transfer Payments (e.g., unemployment benefits)

When would you use expansionary fiscal policy?

The economy is in a recession or experiencing a downturn. It aims to increase aggregate demand by increasing government spending or cutting taxes.

When would you use contractionary fiscal policy?

The economy is overheating, and inflation needs to be controlled. It involves decreasing government spending or increasing taxes.

When we have expansionary fiscal policy, does that cause a budget surplus or deficit?

It usually causes a budget deficit because government spending increases, and tax revenue may decrease.

What is the national debt?

The total amount of money the government owes to external creditors and domestic lenders.

What is MPC and MPS?

• MPC (Marginal Propensity to Consume): The fraction of additional income spent on consumption.

• MPS (Marginal Propensity to Save): The fraction of additional income saved.

• Formula: MPC + MPS = 1.

What is the Money Multiplier? What is the equation for it?

• Money Multiplier: The amount by which a change in the reserve requirement affects the money supply.

• Equation:

  Money Multiplier=1/Reserve Ratio

If MPS in an economy is .1 and the government wants to shift the AD curve right by 50 billion, how much money should they inject into the economy?

• MPS = 0.1, so the money multiplier is 10 (1/0.1)

• To shift AD by 50 billion:

Injection=50 billion/10=5 billion

What are the 3 functions of money?

• Store of Value: Money holds its value over time.

• Unit of Account: Money provides a common measurement for pricing goods and services.

• Medium of Exchange: Money facilitates transactions.

What is M1 money? Give examples.

• Definition: The most liquid forms of money.

• Examples: Currency, coins, checkable deposits (checking accounts).

What are checkable deposits?

Bank deposits that can be accessed using checks or debit cards.

How many districts are in the Federal Reserve system?

There are 12 districts in the Federal Reserve system.

What is the main function of the FED?

To control the money supply and implement monetary policy to maintain price stability and full employment.

The FED is set up as an independent agency to protect it from ________ pressure!

Political pressure.

What are reverse repos? Does the FED change the money supply or just borrow money to temporarily influence the supply of money?

Reverse repos involve selling securities with an agreement to buy them back later. The FED borrows money to temporarily influence the money supply.

What is NOT in M1 money supply?

Savings accounts, certificates of deposit (CDs), and money market funds are not in M1.

What is larger, M1 or M2?

M2 is larger than M1 because it includes M1 plus near-money assets like savings accounts and time deposits.

Who is in charge of the money supply in the US?

The Federal Reserve.

Who backs the US money supply?

The full faith and credit of the U.S. government backs the US money supply.

What would happen if we declared that we are changing money to be backed by apples or iPads?

It would create a commodity-backed currency, and the value would depend on the supply of those goods, potentially causing instability.

How is your purchasing power and price level related?

As the price level increases (inflation), purchasing power decreases.

What are the 2 main ways to stabilize the purchasing power of money?

• Monetary Policy: Control the supply of money.

• Fiscal Policy: Adjust government spending and taxation.

If there is a rapid increase (decrease) in the supply of money, what happens to the purchasing power?

A rapid increase in the money supply leads to a decrease in purchasing power (inflation).

What is the FOMC and what is their job?

FOMC: The Federal Open Market Committee sets monetary policy, particularly concerning open market operations (buying and selling bonds).

What was a contributing factor in the lending market that helped cause the 2007-2008 financial crisis?

The crisis was partly caused by excessive lending (e.g., subprime mortgages) and insufficient regulation.

What is the transactional and asset demand for money? How are they graphically shown, and how do they make the total demand for money?

• Transactional Demand: Money held for everyday transactions.

• Asset Demand: Money held as a store of value.
  Graphically: Both types are plotted on the money demand curve. The total demand for money is the sum of both.

How are increases (decreases) in Nominal GDP related to money demand?

An increase in Nominal GDP leads to an increase in money demand because more money is needed for transactions.

Who is in charge of the supply of money, and graphically how is it shown on the Money Market?

The Federal Reserve controls the money supply. The money supply is shown as a vertical line on the Money Market graph.

How is the equilibrium interest rate determined and how is it shown graphically?

The equilibrium interest rate is determined where the money supply intersects the money demand curve.

What is the relationship between interest rates and bond prices?

Inverse relationship: As interest rates rise, bond prices fall, and vice versa.

What are the 4 tools of Monetary Policy and describe each one with an example?

• Open Market Operations: Buying and selling government bonds (e.g., FED buys bonds to increase money supply).

• Discount Rate: The interest rate at which banks borrow from the FED.

• Reserve Requirements: The fraction of deposits banks must hold in reserve.

• Interest on Reserves: The FED pays interest on excess reserves held by banks.

If the reserve ratio was 10% and the FED sells 3 million Treasury Bonds, what is the immediate effect and the total end result to the supply of money?

• Immediate Effect: The money supply decreases as banks use reserves to purchase bonds.

• Total Result: The money supply decreases.

When the FED buys (sells) bonds and increases (decreases) the supply of money, what will banks do?

• Buy bonds: Banks will have more reserves and lend more.

• Sell bonds: Banks will have fewer reserves and lend less.

If the FED wants to decrease (increase) banks from lending, what can it do?

The FED can increase the reserve ratio or increase the discount rate to reduce lending. To encourage lending, it can decrease the reserve ratio or lower the discount rate.

What are the 2 types of Monetary Policy and what are each of their goals?

• Expansionary Monetary Policy: Aimed at increasing the money supply to stimulate the economy.

• Contractionary Monetary Policy: Aimed at decreasing the money supply to control inflation.

What actions should be taken if the FED is trying to grow (slow) the economy for each of its 4 tools?

• Grow the Economy:

  • Buy bonds

  • Lower reserve requirements

  • Lower interest rates on reserves

• Slow the Economy:

  • Sell bonds

  • Raise reserve requirements

  • Raise interest rates on reserves

Complete the following: If the FED is trying to stimulate the economy, it will want to _____ the supply of money, which will cause interest rates to ______ and thus encourage more _______ lastly pushing the AD curve to the _________.

Increase, fall, investment, right.

Know how the Demand for money graph, investment demand graph, and AD/AS graph are all connected.

The demand for money influences interest rates, which affects investment. Investment shifts the AD curve, which affects output and prices in the economy.

Exports vs. Imports, define them.

• Exports: Goods and services produced domestically and sold abroad.

• Imports: Goods and services purchased from abroad.

What is the foreign exchange market, what is traded on it, and is a weak or strong currency better to have?

• Foreign Exchange Market: A global marketplace where currencies are exchanged.

• What is traded: Currencies are traded on this market.

• Is a weak or strong currency better: A strong currency is generally better because it allows for cheaper imports and favorable exchange rates.