12/17 QUIZ: Basics Of Economics

Inflation, Money and the Federal Government

How is inflation rate determined by?

Comparing the price level at two periods of time.

Creeping Inflation

A gradual increase in prices, typically measured at a rate of 1-3% annually, which is generally considered manageable for the economy.

Galloping Inflation

A rapid and significant increase in prices, often exceeding 10% annually, which can disrupt economic stability.

Hyperinflation

When its totally out of control, often exceeding 50% per month, leading to a collapse in the value of currency.

What are the causes of inflation?

Demand-pull, cost-push, wage-price spiral, excessive monetary growth

When does Demand-pull inflation occur?

All sectors of the economy try to buy more goods and services than the economy can produce. As consumers, businesses, and the government try to buy goods, shortages occur and prices go up.

When does Cost-push inflation occur?

Input costs, ESPECIALLY labor, drive production costs up.

When does Wage-Price spiral occur?

Higher prices force workers to demand higher wages to deal with higher prices. Producers raise their prices even more to compensate for paying their employees higher wages.

When does Excessive Monetary Growth occur?

The money supply grows faster than the real GDP. Any extra money created by the fed will increase some group’s purchasing powers.

What are some consequences of inflation?

Dollar buys less, people on fixed incomes especially hurt, causes changes in spending/saving habits, borrows are helped, lenders are hurt.

Inflation is simply put as..

Too much money chasing too few goods.

What are goals for the US economy?

Stable prices, steady economic growth, low unemployment.

What is money?

Any commodity or token that is generally accepted as a means of payment.

What is “means of payment”?

A method of settling debt.

What are the three vital functions that money performs?

Medium of exchange, unit of account makes trade easier, store of value (can be held and used later).

What is Fiat Money?

Objects that are money because the law decrees or orders them to be money.

What is M0?

The total of all physical currency in circulation, including coins and paper money, as well as balances held by the central bank.

What is M1?

All physical currency, demand deposits, and other liquid assets that can be quickly converted into cash.

What is M2?

A measure of the money supply that includes physical currency, demand deposits plus savings accounts, time deposits, and other near-money assets.

What are the goals of Economic Policy?

Keep prices stable

How does the U.S Government try to keep inflation low?

Monetary Policy and Fiscal Policy

What is Monetary Policy?

Federal Reserve Bank controls the money supply. Influences the interest rate

What is Fiscal Policy?

Congress passing laws on taxes and spending. More taxes slows consumption. More spending speeds up consumption.

What is an interest rate?

It is the process of borrowing cash or lending cash now.

What does the fed do?

Manages the country's monetary policy, regulates banks, maintains financial stability, and provides financial services to the government and public.

What is a security?

A financial instrument that represents an ownership position, a creditor relationship, or rights to ownership as represented by an option.

What does the fed PURCHASING do for Open Market?

Increases the money supply (expansionary)

What does the fed SELLING do for Open Market?

Decreases the money supply (contractionary)

If the fed buys money from banks…

Banks can now loan money out.

What is the Expansionary Money Policy?

Increases the money supply and stimulate economic growth, typically through lower interest rates and increased bank lending.

If there is MORE MONEY in the system…

It has less value and lowered interest rate.

If there is LESS MONEY in the system…

it has more value and higher interest rates.

What is the equation for the money multiplier?

(1/r) X original reserve amount

What is the discount rate?

The interest rate that the fed chargers other banks to borrow from it.

HIGHER interest rates…

LESS borrowing which contributes to less money in the economy

LOWER interest rates…

MORE borrowing which contributes to more money in the economy.

The fed is the

Lender of Last Resort

What is the reserve requirement?

The minimum amount of reserves a bank must hold against deposits, set by the Federal Reserve.

What are Open Market Operations?

The buying and selling of government securities by the Federal Reserve to control the money supply.

What is the Discount Rate?

The interest rate charged by the Federal Reserve to banks for short-term loans, influencing overall lending rates in the economy.

By INCREASING the required reserve ratio…

the Fed can force banks to hold a LARGER quantity of M0.

By INCREASING the discount rate…

the Fed can make it MORE COSTLY for the banks to borrow reserves.

By SELLING securities in the open market…

the Fed can DECREASE the monetary base.

By DECREASING the required reserve ratio…

the Fed can permit the banks to hold a SMALLER quantity of monetary base.

By DECREASING the discount rate…

the Fed can make it less costly for the banks to borrow monetary base.

By BUYING securities in the open market…

the Fed can INCREASE the monetary base.

How does CONGRESS respond to inflation?

Implement fiscal policies, such as reducing government spending or increasing taxes, to help control inflation.

How does the PRESIDENT respond to inflation?

Monetary policy recommendations, fiscal policies like tax cuts or increases in government spending, and by promoting economic growth initiatives.

What is discretionary spending?

When congress and the President pass new bills/spending packages. It helps peoples ability to spend/consume to get out of an recession. (Stimulus paychecks during COVID)

What is the Fiscal Multiplier Effect?

Every dollar the government spends does MORE than $1 change in the economy.

What is the Crowding Out Effect?

Government borrows more money that increases the interest rate. People can’t afford to borrow money for personal or business use, leading to reduced investment and consumption.

What is “new goods bias”?

Newer things are often better but are more expensive than older products.

What is “quality change bias”?

As the quality of products improve, so does the cost (not inflation).

How do you calculate CPI?

(cost of current basket/cost of base period basket) x 100

How do you calculate inflation using CPI?

Inflation rate = (cpi current - cpi previous)/cpi previous x 100