Macroeconomics Exam 2

What is inflation?

A general increase in prices over time

What is a market basket?

Collection of goods and service that used to measure changes in consumer prices

Are all items in the Market Basket equally important?

No, some items hold more weight than others depending on price

What are heavily weighted items?

Housing, Food, Transportation

What are moderately weighted items?

Clothing, Entertainment

Why do market basket weights matter?

Price increases in heavy items have a greater impact to increasing the inflation rate

What does a 6% inflation rate mean?

Overall price level has increased by 6% in comparison to the previous year, not that every item has individually increased by 6%

What is the Consumer Price Index?

Has a fixed market basket, higher weight in housing and is based on out-of-pocket costs

What is the Personal Consumption Expenditure?

Not fixed, is based on consumer spending so the item weight may vary, higher weight in healthcare and is based on third-party costs

CPI vs PCE?

CPI measures changes in prices paid by consumers and third -parties, and has a fixed basket.

PCE measures changes in prices consumed by households and covers a broader range

What is the conventional story for inflation?

when demand exceeds supply or increase in money supply

Why do firms increase prices?

They increase prices because of inflation, inflation leads to higher operation & production costs

What is Cost-Push Inflation?

It’s when inflation causes costs of production and operation to go up, leading to higher product prices

What is Demand Pull Inflation?

When demand is higher than supply, so businesses raise prices because they’re willing to buy more

What is price gouging?

When businesses take advantage of shortages and emergencies to charge more

What is the conventional answer to inflation?

Increase interest rates

How do higher interest rates fight inflation? - Demand

Borrowing becomes more expensive

Consumers will spend less

So businesses will invest less

leading to a decrease in demand

What are other ways to fight inflation? - Supply Side

Invest in domestic production, build new factories which create new jobs

Increase child/elder care, by allowing people to not have to take care of the children/elderly they will be able to work instead

What four groups are excluded from the work force?

Prisoners, People in the nursing homes, mental health patients, active-duty soldiers

What does it mean to be considered unemployed?

Doesn’t have a job

Is available to work

Has actively looked for a job within the last 4 weeks

What does it mean to be out of the labor force?

Doesn’t have a job

Is not looking for work

Is a student, retiree, or stay-at-home

What is U-3 unemployment?

It is an official unemployment rate and it counts people that aren’t looking for work, however it does not include involuntary part-time workers

What is U-6 unemployment?

It is a broader measure of unemployment, it includes the unemployed, part-time workers, and those who are marginally attached

What is cyclical unemployment?

When there aren’t enough jobs in the economy and is caused by economic recessions and downturns

What is structural unemployment?

When there are enough jobs in the economy, but those who are unemployed don’t hold eligible skills to get them

Which type of unemployment is considered temporary or permanent?

Cyclical is temporary because its connected to the business cycle

Structural can be more long-term because it is caused by a need for workers to have certain skills

What is the solution to cyclical unemployment?

Lower interest rates, Increase government spending, and lower tax rate

What is the solution to structural unemployment?

Increase educational programs, invest in developing industries, increase job placement programs, and have tax incentives for businesses

What is the Beveridge curve?

Shows the relationship between unemployment and available jobs

What is full employment?

Jobs can be found easily and there is no serious cyclical unemployment

What are the costs of a hot economy caused by full employment?

Higher inflation

Tight job market

Employees have power over companies

What is the Phillips Curve?

shows the relationship between unemployment and inflation caused by wages, prices, and unemployment

What is the wage-price spiral?

a cycle between unemployment and bargaining power that effects wage amount, prices, and inflation

What is the 13th Amendment Loophole?

The 13th amendment abolished slavery and free labor, except as a punishment for crime

What is potential GDP?

the max. sustainable level of goods and services that can be produced with efficient resource output

What is an output gap?

Difference between actual and potential GDP

What are two ways to close the output gap?

raise our economic performance and lower our potential GDP

What are the 5 Determinants of Economic Growth?

Natural Resources

Entrepenurship

Capital Accumulation

Technological Development

Industry Policy

What is industrial policy?

It is research and development that is funded by the government, in which their findings are for commercial use

What is a business cycle?

natural fluctuation in our economic activity

What is the Expansion phase?

increasing economic activity, increases in consumer spending, business investments, GDP, inflation, employment, and wages

What is the Peak Phase?

Highest point in our economic activity, leads to a hot economy and increase in consumer spending, business investments, and employment

What happens to GDP during the Peak Phase?

Since we have reached such a high GDP, we have a tighter production limit

What happens to employment in the Peak Phase?

There is full employment during this phase, leading to a tight labor market

What is the downside of the Peak Phase

Since we have a hot economy during this phase, and we have increases in spending and available money, we see an increase in inflation

What is the Contraction Phase?

Decrease in GDP, investment, consumer spending, inflation and higher unemployment

What is the Trough Phase?

Lowest point in our activity, weak GDP, higher unemployment, and lower spending and investment

What does the Trough Phase mean?

It is our recovery phase, lowering inflation. It has no timeline

What does the Contraction Phase mean?

It means that our economic activity may be slowing down, it does not always mean a recession

How does NBER describe a recession?

A decrease of GDP between two periods of time

What is Okun’s Law?

Relationship between GDP and Unemployment

What is pro-cyclical spending?

spending moves with the business cycle

What is counter-cyclical spending?

spending moves against the cycle

What types of economic activity are pro-cyclical?

consumption

investments

imports

What types of economic activity are counter-cyclical?

government spending, educationW

What is the Federal Reserve?

The Central bank of the United States

What is a Central Bank?

A financial institution responsible for the management of a country’s monetary system

What is Monetary Policy?

actions and tools used by a nation’s central bank to manage the money supply, interest rates, and economic stability

What is the Contractionary Monetary Policy?

When the Federal Reserve raises the interest rates, and slows down economic activity to reduce inflation

Why is Contractionary Monetary Policy implemented?

It is used to fight inflation

How does Contractionary Monetary Policy fight inflation?

It increases interest rates, making borrowing more expensive leading to lower spending and therefore decreasing inflation

What is Expansionary Monetary Policy?

When the Federal Reserve lowers interest rates to encourage more economic activity

Why is Expansionary Monetary Policy implemented?

To stimulate the economy during a recession

How does Expansionary Monetary Policy fight inflation?

It lowers interest rates, making borrowing cheaper and increasing spending overall

What is a bank’s deposits at the Federal Reserve called?

They are called reserves

What is the federal funds rate?

The interest rate banks charge each other for overnight loans of reserve balances

Does the Federal Reserve directly control interest rates commercial banks charge?

It does not directly influence these rates, but they are influenced through monetary policy rates

What is the Interest on Reserve Balances (IORB)?

Interest the Fed Reserve pays banks on reserve balance they hold at the Fed

What does Interest on Reserve Balances do (IORB)?

It helps influence short-term interest rates,

and when the IORB increases, banks have more reason to hold reserves rather than lend them at lower rates

What is Open Market Operations (OMO)?

The buying and selling of government securities by the Federal Reserve to influence financial conditions and reserve balances

What does Open Market Operations do?

The purchasing/selling of securities affects the reserves to the banking system and financial conditions

What does the Purchase of Securities do (OMO)?

It adds reserves to the banking system and eases financial conditions

What does the Selling of Securities do (OMO)?

It removes reserves of the banking system and tightens financial conditons

What is a Discount Rate?

An interest rate charged by the Federal Reserve when eligible banks borrow directly from the Reserve through the discount window

What does a Discount Rate do?

Depending on the rate the discount makes the borrowing more cheap/expensive

When was the Federal Reserve created?

It was created on December 23. 1913

Who created the Federal Reserve and Why?

It was created by the US Congress, it was made to create a more stable banking and financial system to reduce the risk of financial panics

What is the Central Bank Structure?

Federal Reserve Board

Federal Reserve Banks

Federal Open Market Committee

What affects Interest Rates in Monetary Policy?

Interest on Reserves Balance (IORB)

Open Market Operations (OMO)

Discount Rates

What is the Federal Reserve Board?

Seven Members that oversee the federal reserve and help guide monetary policy

What are the Federal Reserve Banks?

12 Regional Federal Reserve Banks that carry out many central bank operations and provide service to banks by supervision

What is the Federal Open Market Committee?

They are responsible for setting monetary policy through open market operations, and they set the target range for the federal funds rate

What are the Central Bank’s Responsibilities?

Monetary Policy

Max. Employment

Stable Prices

Bank Supervision

Financial Stability

Payment Systems