Macro Exam Chapters (5,6, 8)

Monetary System, Inflation, Unemployment and Labor Market

Money

Money is the stock of assets that can be readily used to make transactions.

Money: Functions

▪ medium of exchange
we use it to buy stuff
▪ store of value
transfers purchasing power from the present to
the future
▪ unit of account
the common unit by which everyone measures
prices and values

Fiat money

Has no intrinsic value but is a government decree
▪ Example: the paper currency we use

Commodity money

Has intrinsic value
▪ Examples:
gold coins,
cigarettes in P.O.W. camps

money supply

the quantity of money available in the economy

Monetary policy

The control over the money supply

C, M1, M2

1. Currency, 2. Currency + demand deposits,
   traveler’s checks, and other
   checkable deposits. 3. M1 plus retail money market
   mutual fund balances, savings
   deposits (including money
   market deposit accounts), and
   small time deposits

Monetary policy is conducted by a country’s?

central bank.

The U.S.’ central bank is called?

Federal Reserve

The fed uses what to control the money supply

open market operations

Decisions about monetary policy in the United States
resides with the __________

Federal Open Market Committee (they meet every six weeks to discuss and set monetary policy)

Congress gave the Federal Reserve Bank a dual
mandate: what are the 2 mandates

1. Stable prices
2. Maximum sustainable employment

how does the Fed control the money supply

open-market operations, the purchase and sale of
government bonds.

Open-market operations

the purchase and sale of government bonds to control the money supply.

Reserves

The portion of deposits that banks have not lent.

100-percent-reserve banking

a system in which banks hold all deposits as reserves.

Fractional-reserve banking

a system in which banks hold a fraction of their
deposits as reserves.

Bank capital:

the resources a bank’s owners have
put into the bank

Leverage.

the use of borrowed money to supplement
existing funds for purposes of investment

discount rate

the interest rate the Fed charges on
loans to banks

reserve requirements

Fed regulations that impose a
minimum reserve-deposit ratio

interest on reserves

The Fed pays interest on bank
reserves deposited with the Fed

Reserve Deposit ratio

the fraction of total customer deposits that a commercial bank holds in reserve as cash in its vaults or as deposits with the central bank, rather than lending out or investing

Capital requirement:

minimum amount of capital mandated by regulators
▪ intended to ensure banks will be able to pay off
depositors
▪ higher for banks that hold more risky assets

Inflation

Prices rise

Deflation

Prices fall

Disinflation

inflation growth is slowing

ShoeLeather costs

Time/Effort: having smaller cash balances. Having to go to the bank more often and deposit/withdrawl money (more costly)

Menu costs

costs of chnaging prices.

• Print new menus with updated prices.

• Update prices on your website.

• Change prices on your ordering system.

Relative price distortions

Firms facing menu costs change prices infrequently.
▪ Example:
A firm issues new catalog each January.
As the general price level rises throughout the year,
the firm’s relative price will fall.

Unfair tax treatment

Some taxes are not adjusted to account for
inflation, such as the capital gains tax.

General inconvenience

Inflation makes it harder to compare nominal
values from different time periods. This complicates long-range financial planning.

seigniorage

The “revenue” raised from printing money

inflation tax

Printing money to raise revenue causes inflation.
Inflation is like a tax on people who hold money.

What causes hyperinflation?

Hyperinflation is caused by excessive money
supply growth:
▪ When the central bank prints money, the price
level rises.
▪ If it prints money rapidly enough, the result is
hyperinflation.

Real variables

What that money can actually buy (purchasing power). (tied to output)

Nominal variables

Money you earn Ex) hourly wage pre inflation and tax (tied to price)

Classical dichotomy

the theoretical separation of real and nominal
variables in the classical model, which implies
nominal variables do not affect real variables.

Neutrality of money

Changes in the money
supply do not affect real variables.
In the real world, money is approximately neutral
in the long run.

Unexpected Inflation

Price of hair cut today vs price of hair cut 100 years ago.

monetary base

The monetary base is the total amount of money created by the Federal Reserve that exists as:

1. Currency: Physical cash (dollar bills and coins) held by the public and banks.

2. Bank reserves: Money that commercial banks keep in their accounts at the Federal Reserve.

money multiplier

Explains how banks can increase the money supply by lending out money that people deposit.

Unemployent Rate

Unemployed / Labor Force

Natural rate of unemployment

The average rate of unemployment around
which the economy fluctuates.
▪ In a recession, the actual unemployment rate
rises above the natural rate.
▪ In a boom, the actual unemployment rate falls
below the natural rate.

s = rate of job separations

fraction of employed workers
that become separated from their jobs

f = rate of job finding

fraction of unemployed workers
that find jobs

steady state

he labor market is in
steady state, or long-run equilibrium,
if the unemployment rate is constant.

Why is there unemployment

If job finding were instantaneous (f = 1),
then all spells of unemployment would be brief,
and the natural rate would be near zero.
▪ There are two reasons why f < 1:
1. job search
2. wage rigidity

frictional unemployment

caused by the time
it takes workers to search for a job

Sectoral shifts

When the economy changes, some jobs become more needed, while others become less needed.

Example 1 – Technology:

• More people need computer repairs.

• Fewer people need typewriter repairs.

Example 2 – International Trade:

• More jobs in industries selling goods to other countries.

• Fewer jobs in industries competing with cheaper foreign goods.

Govt programs affecting unemployment include

Govt employment agencies
disseminate info about job openings to better
match workers & jobs.
▪ Public job training programs
help workers displaced from declining industries
get skills needed for jobs in growing industries.

Unemployment insurance

UI pays part of a worker’s former wages for a limited time
after the worker loses his/her job.

Benefits of UI

By allowing workers more time to search,
UI may lead to better matches between
jobs and workers,
which would lead to greater productivity and
higher incomes.

Reasons for wage rigidity

1. Minimum wage laws
   2. Labor unions
   3. Efficiency wages

Wage Rigidity:

When wages (pay) don't easily change, especially when they need to decrease.

Simple Example:

• A company is struggling and needs to cut costs.

• Instead of lowering workers' wages, the company lays off employees.

• This causes unemployment.

Labor unions

Unions exercise monopoly power to secure higher
wages for their members.

Insiders

Employed union workers whose interest is
to keep wages high.

Outsiders

employed non-union workers who
prefer equal wages, so there would be enough jobs for
them.

Efficiency wages

Theories in which higher wages increase worker
productivity

Discouraged workers

workers who have given up on
looking for a job and are considered out of the labor force.

Marginally attached workers

Persons not in the labor
force who want and are available for work and who have
looked for a job but have not recently looked for work.