Econ 2020 Final

What is Fiscal Policy

Fiscal policy refers to the use of government spending and taxation to influence the economy. It aims to stabilize economic growth, control inflation, and reduce unemployment.

Expansionary fiscal Policy

involves increasing government spending and/or decreasing taxes to stimulate economic growth.

Contractionary fiscal policy

involves decreasing government spending and/or increasing taxes to slow down economic growth and reduce inflation.

How is the government balance affected by countercylical fiscal policy

During economic downturns, the government may increase spending and lower taxes, leading to higher deficits, while in boom periods, it may reduce spending and increase taxes to create surpluses.

Multiplier Fiscal Policy

When there is an increase in fiscal expenditure there is a ripple effect that will cause people to continue to spend money or investand thereby amplifies the initial spending effect on the economy.

MPC (Marginal Propensity to Consume)

The amount someone spends when getting new paycheck or money

Change in Consumption / change in income

Spending Multiplier

Total impact on spending from initial change of a given amount of income

1 / 1-MPC

Why doesn’t Fiscal Policy always work

May not always work because of lags in the economy

Recognition lag

Economists have trouble recognizing if an economy is in a recession or boom because data comes out with a delay.

Implementation lag

Takes time for policies to get passed in law

Impact Lag

The multiplier takes a while to take in to effectand show the full impact on the economy.

How to Alleviate Lag Problems

Automatic Stabilizers

Examples of Automatic Stabilizers

Progressive Tax income rates

Lower taxes on corporate profits

unemployment compensation

welfare programsand social security benefits.

Crowding out

When there is an increase in government spending but C and I still decrease

Saving Shifts (New classic critique)

People will save their money due to expected higher tax rates from fiscal policy

Examples of Supply Side of Fiscal Policy

Small business grants

loans to large corporations

hospital aid

research and development tax credits

education grants

All of these give incentives and take long time to take affect

Laffer Curve

Shows the relationship between tax rate and tax revenue

What are the three functions of Money

Medium of exchange

unit of account

Store of value

Medium of exchange

A function of money that enables it to be used as a method for buying and selling goods and services.

Barter

No commonly accepted medium of exchange (have to be coincidence that one parties needs the others givings)

Commodity money

use of an actual good as medium of exchange

Commodity Backed Money

money that is backed by a physical commodity such as gold or silver, giving it intrinsic value.

Fiat Money

Money that has no value to it but is traded

Unit of Account

measure how things are priced

Store of value

how money is stored

m1

Right now money (liquid), cash, checking account

m2

A measure of the money supply that includes M1 plus savings accounts, time deposits, and retail money accounts (brokerage account)

Fracitonal reserve Banking

When banks hold a certain about of their deposits as reserves

Bank run

when many people try to withdraw their money at the same time

Moral Hazard

When banks loan out all their money because they know they are protected from the consequence of this

Reserve Ratio

ratio banks decide to reserve and lend out

Simple money multipler

how much the money multiplies when banks loan out their money

1/ rr

Federal Funds

The amount private banks deposits holds on reserves at the federal bank

Federal fund rates

How much banks charge each other for loans

Discount loans

loans from federal bank to private bank

Discount Rate

The interest rate the Federal bank uses on the loans it provides to private banks.

IORB (interest on reserve bank)

The interest private banks earn to hold reserves at the fed in excess of required reserves, incentivizing banks to maintain minimum balances.

Open Market Operations

Purchase or sales of bonds by a central bank

Quantitative easing

Central bank buys longer term treasury securities targeting certain markets

Discount window

A facility that allows banks to borrow money from the central bank, typically on a short-term basis, to meet temporary shortages of liquidity.

Lending facilities

provided by the central bank to help financial institutions manage liquidity needs, often including the discount window and other programs.

How does open market operations increase/decrease money supply

Buying securities increases the money supply

Selling securities decreases the money supply

How to implement monetary policy

Fed will use IORB to influence short-term interest rates and control money supply.

Expansionary monetary policy

Fed will decrease IORB to increase incentives for private banks to lend out more leading to lower interest and higher demand

or

use open market operations

Why isn’t monetary policy useful all the time

Because as money supply increases money will devalue because of higher prices

but in short run they will work

Why is Unexpected inflation bad for some people

Some people who have signed contracts for wages right before a rise in inflation will be cooked

How does Monetary Policy affect hte long run (monetary neutrality)

There is no affect because in the long run, money supply does not influence real variables such as output or employment, affecting only prices.

Phillips curve

relaitonship between unemployment and inflation

higher inflation leads to lower unemployment

Adaptive expectaitons theory

people will base inflation off of previous experiences

StagFlation

Increase in interest rates and unemployment

Active vs Passie Monetary Policy

active - counteracts against economic fluctuations

passive - influence money supply and price levels

Expected Inflation with Monetary Policy

Supply curve will shift left with demand shifting out causing no change in unemployment or GDP but rise in price level

Trade Balance

difference between total exports and total imports

Comparative Advantage

Which producer has a lower opportunity cost to produce a good

positive sum game both parties gain

Protectionism

policies that restrict international tradeto protect domestic industries.

Tariffs

Tax on imported goods

Quotas

limits on products that can be imported into a country

Why Trade barriers are needed

Infant Industries - new industries need trade protection to develop technologies and such

National Security

Dumping - foreign suppliers sell costs at lower prices than in its home country

Exchange rate

price of foreign currency

Derived Demand

Demand for a good or service that derives form the demand for another good or service

ex.

buy chocolate from belgium in euros but euros is also used in other countries as well

Currency Appreciation

currency increases in value compared to relative currencies

Currency Depreciation

currency decreases in value relative to other currencies

Price of foreign currency relative to demand

price of euros falls increase in demand for that country goods and services

price of euros increase, decrease in demand for that country goods and services

Foreign financial assets/interest rates relative to demand

If interest rates of anohter country rises the demand for its currency increases

vice versa

Exchange rate manipulation

Increasing the supply of a currency decreases the exchange rate

vice versa

Pegged exchange rates

pegged is fixed exchange rates set by govenrments

Flexible exchange reates

are exchange rates that fluctuate based on market forces without a fixed value.

Law of one Price

after accounting for shipping costs and trade barriers products should be identical in price in different locations

Purchasing power Parity

unit of currency should be able to buy the same amount of goods in different countries.

Why PPP doesn’t hold

goods and services usually arent identical

some services are not tradable

Trade barriers

shipping costs

BOP (balance of payments)

Payments between that country and rest of world

Current Account

tracks payments for goods and services gifts and current income from investments

Capital Account

tracks payments for real financial assets

stocks bonds

real assets (homes)

Equaiton for Account balances

current account balance + capital acocunt balance = 0

Why do trade deficits occur

wealthy consumers can import more

growing economies offer higher investment returns

Low domestic saving rates

government borrowing