Econ Final Exam

Fiscal policy

use of government spending or taxes to achieve economic goals

Crowding Out Effect

a decrease in private-sector spending due to increased government
borrowing

Supply-side economics

the theory that creating incentives for individuals and firms to
increase productivity results in rightward shifts of the LRAS curve

Recognition time lag

time required to gather information and recognize problems

Action time lag

time between recognizing a problem and implementing policy to solve it

Effect time lag

time between policy implementation and the effect on the economy

automatic stabilizers

mechanisms that alter tax and spending levels in response to changes in
economic conditions without direct intervention by policymakers

Government budget deficit

the amount by which government spending exceeds
revenues for a given time period (for FY 2024, budget deficit = $1.83 trillion)

To pay for a budget deficit

the government borrows money by selling Treasury bonds

Government budget surplus

the amount by which government revenues exceed
spending for a given time period

Public debt (national debt)

the sum of all outstanding Treasury bonds; it is the
accumulation of deficits from prior years plus the interest owed

Debt-to-GDP ratio

compares the amount owed to the size of an economy; it reflects the
ability to repay the debt
o United States: 123% (debt = $35.46 trillion and GDP = $28.82 trillion)

Burdens of the Public Debt

1) Crowding-out effect – Government borrowing raises interest rates, investment spending
on capital goods decreases, and the future productivity capacity decreases.

2) Debt owned by foreigners – When the debt comes due in the future, the government
raises taxes on U.S. citizens to pay for it, the money is sent abroad, and U.S. income and
consumption decrease.

the relationship between a trade deficit and budget deficit

A larger budget deficit can contribute to a larger trade deficit (a country’s imports are greater than its exports)

• If the U.S. budget deficit increases through borrowing, then U.S. interest rates rise.
• Some foreigners will buy U.S. bonds rather than U.S. exports.
• U.S. exports decrease, and the trade deficit becomes larger

barter

the direct exchange of goods
and services for other goods and services; for an exchange to happen, there must be a double coincidence of wants

In its role as a medium of exchange, money allows:

o reduces transaction costs (time spent exchanging goods and services)
o allows individuals to specialize
o makes an economy more efficient which contributes to economic growth

Liquidity

how easily and quickly an asset can be converted to cash

The opportunity cost of holding money

is the interest that could have been earned by holding an alternative asset such as a bond.

Financial intermediaries

institutions that accept savings from households, businesses, and
governments and make loans to other households, businesses, and governments; serve as “middlemen” by transferring funds from savers to borrowers; includes banks, savings banks, S&Ls, credit unions, etc.

Fractional reserve banking

system in which banks hold a portion of deposits “on reserve” and
lend the rest out

One of the Fed’s tools: Open market operations

the buying or selling of existing U.S. government securities (bonds) by the Fed
o When the Fed buys a bond, money is deposited in the bond seller’s bank account.

transactions demand

money held for everyday purchases

precautionary demand

money held for emergencies

asset demand

money is held as a store of value due to its liquidity and lack of risk

The demand curve for money

is downward sloping; at higher interest rates people hold less
money.

The tools available to the Fed are:

• Open market operations
• Discount rate – interest rate the Fed charges for reserves it lends to banks
• Reserve ratio
• Interest rate paid on reserves held at the Fed

Currently, the primary tool used by the Fed to keep the federal funds rate within the target range

is the interest rate paid on bank’s reserves held at the Fed.