Macro Theory Set #2

What are the Fed’s dual mandate goals

The Fed is mandated by Congress to promote maximum employment and price stability

What does it mean to conduct monetary policy?

FOMC conducts monetary policy by setting a target range for the federal funds rate, a key interest rate in the economy. It does this with the goal of moving the economy toward the Fed’s dual mandate

What does it mean to implement monetary policy?

The Fed implements monetary policy by using its tools to steer the federal funds rate into the target range set by the FOMC

What is the Fed’s primary tool for implementing monetary policy

Interest on reserve balances is the Fed’s primary tool for adjusting the federal funds rate

How does the interest on reserve balances rate serves as a reservation rate

Banks will not lend or invest for less than they can earn by depositing their funds at the Fed.

Give an example of banks arbitraging between the federal funds market and interest on reserve balances

If the federal funds rate is far enough below the interest on reserve balances rate, banks will borrow funds in the federal funds market at the federal funds rate and deposit them at the Fed to earn the interest on reserve balances rate.

How does arbitrage ensure that the federal funds rate does not fall far below the interest on reserve balances rate

As banks borrow at the federal funds rate and deposit those monies to earn the interest on reserve balances rate, the increase in demand for federal funds will push the federal funds rate higher and close the gap

What is the discount rate?

The discount rate is the interest rate charged by the Fed to banks for loans obtained through the Fed’s discount window

How does the discount rate act as a ceiling for the federal funds rate?

Banks should not be willing to pay a higher interest rate to borrow the money in the federal funds market or any other market

How does the Fed use open market operations to ensure reserves remain ample?

The Fed buys U.S. Treasury securities and pays for these securities by crediting the reserve account of the seller, thereby increasing reserves in the banking system

What would the FOMC do if the economy is in recession and not meeting its maximum employment and price stability dual mandate?

The FOMC would lower the target range for the federal funds rate. Then, the Fed would lower its administered rates—interest on reserve balances rate, overnight reverse repurchase agreement offering rate, and discount rate—which encourages more accommodative financial conditions and boosts spending by households and businesses, which in turn encourages production and employment and may put upward pressure on prices

Deflation

negative inflation rate

disinflation

falling levels of inflation

Endogenous variable

included and explained in model: price, supply, and demand

Exogenous variables

included, but not explained in model: price of inputs or income

Sticky prices

in the short run prices are fixed

Long run

prices adjust in the long run

stock

fixed quantity at a point in time ex. bank balance

flow

rate of change ex. income

GDP

market value of all final goods and services in a given period

GDP components

C-consumption + I-investment + G-gov. spending + NX-net exports

GNP

GDP+net factor payments (payments received - payments sent abroad)

Whats included in GDP

only new goods, inventories, capital spending, government spending, and exports

CPI

measures the average change over time in the prices paid by urban consumers for a fixed market basket of consumer goods and services

GDP deflator

measures the changes in prices for all new, domestically produced, final goods and services in an economy.

PCE

measures the changes in the prices of goods and services purchased by consumers in the United States. It is the Federal Reserve's preferred inflation metric because it captures a broader scope of spending and shifts dynamically as consumer habits change. (synonymous with CPI)

Lasperes index

CPI & PCE

Paasche index

GDP deflator

household survey

a data collection method that interviews individual households to gather direct information on employment, income, consumption, and living standards

establishment firm survey

is an economic data collection method that gathers information directly from business locations (establishments) rather than individual households.

Production function

Y=F(K,L)

Constant returns

Y=K+L

Increasing return

Y=K²+L²

decreasing return

Y=√K+√L

Profitt maximizing condition equations

MPK = R/P and MPL = W/P

Cobb Douglas production function

model used in economics to show the relationship between technological inputs and the total amount of goods produced. It estimates how efficiently an economy or a specific firm can turn labor and capital into physical output.

Gini coefficient

he coefficient is expressed as a number between 0 and 1 (or 0% to 100%):

a statistical measure used to gauge economic inequality within a population. It measures how evenly income or wealth is distributed across a country's citizens.

Definiton of money

Stock of assets that can be readily used to make transactions

Functions of money

-store of value

-unit of account

-medium of exchange

Types of money

-fiat (legal tender)

-commodity

-other (bitcoin)

leverage ratio

total assests/total capital

parts of balance sheet

Assets: reserves, loans, securities Liabilities: deposits, debt, and capital/equity (both sides must equal one another)

trick to find insolvent amount

1/leverage ratio

Fishers equation of exchange

MV=PT

Cambridge equation

MV=PY

Quantity theory of money

the general price level is correlated to amount of money in circulation.

Seigniorage

revenue raised by the printing of money

fisher effect

one to one relationship between inflation and nominal interest rates

fisher equation

I= r + Eπ

costs of expected inflation

time coordinating effort, tax distortion, cost of relative price variability

cost of unexpected inflation

arbitrary redistribution of wealth

benefits of inflation

relieves tension from downward nominal wage rigidity and helps escape liquidity trap

Recession

2 consecutive quarters of negative growth

stagflation

elevated unemployment and high price level

Leading indicators

fluctuate in advance of economy wide changes

Euphoria

inflation and employment moving in same direction

Gov purchase multiplier

1/1-MPC

tax multiplier

-MPC/1-MPC (tax multiplier is weaker than gov spending)

Dovish

favors economic, growth doesn’t mind inflation

Hawkish

strongly opposes inflation

spending hypothesis great depression

caused by lack of spending

Money hypothesis

an economic theory which argues that the Great Depression was fundamentally caused, and its severity drastically worsened, by a massive contraction of the money supply and the failures of the Federal Reserve

debt deflaiton theory

an economic framework introduced by economist Irving Fisher in 1933. It argues that the Great Depression was triggered and amplified by the toxic interaction of excessive private debt and falling prices (deflation).

Per capita

viewing economic phenomena on a per person basis is more insightful

Golden rule level of capital (unrealistic scenario)

In this scenario, the economy has too much capital This is known as being dynamically inefficient The economy is saving so much that the cost of maintaining, replacing, and depreciating the massive stock of machinery outweighs the output it generates.

Golden rule level of capital (realistic scenario)

In this scenario, the economy has too little capital While the economy is technically dynamically efficient, it is sacrificing potential long-term well-being because workers do not have enough tools or machinery to maximize their consumption capacity.

Solow growth model

population grows too fast and reduces steady state capital

Malthusian theory

population growth makes everyone poorer and will outpace level of resources

Kremer growth theory

bigger population lead to more wealth through more technological process and idea generation

Creative destruction

older and less effect products and firms are outcompeted by newer more innovative counterparts.

Balanced growth

variables grow at the same rate in a steady state

keynesian 1930 theory

will have to work less to achieve same results. proved incorrect as out consumption and desires increased.

sacrifice ratio

Multiply the sacrifice ratio by the number of percentage points by which inflation must fall.