4/24 - Macro Final Lecture (review)

Short Answer Question

• The exam includes a single short answer question related to stagflation and monetary policy.
  • Question: Suppose the economy is experiencing stagflation. Is the modern chairman of the Federal Reserve more likely to respond with an expansionary monetary policy or contractionary monetary policy?
  • Answer: Contractionary monetary policy is preferred because inflation is the top priority, even though in the long run, unemployment can fix itself.

Exam Structure

• Exam Consists of:
  • 29 multiple choice questions
  • 1 short answer question
• Students may need to analyze provided graphs but are not required to draw them.

Multiple Choice Policies

• Expansionary vs. Contractionary Monetary Policy:
  • Expansionary Policy: Used to shift the economy from point A to point B to stimulate growth.
  • Contractionary Policy: Would be the response to inflation concerns; involves actions like selling treasury securities or raising the discount rate.

Federal Reserve Functions

• The Federal Reserve (Fed) can implement monetary policy through:

  • Buying treasury securities
  • Lowering the discount rate
  • Lowering the required reserve ratio

• Contractionary policy involves:

  • Selling treasury securities
  • Raising the discount rate
  • Raising the required reserve ratio

Fiscal Policy

• Congress and the president implement fiscal policy, dealing with:
  • Government Purchases: To stimulate the economy, it involves increasing government purchases and lower taxes (i.e., business and income taxes).
  • Effects of Tax Changes:
  • Lowering business taxes increases funds for investment.
  • Lowering income taxes increases disposable income for consumers.

Graph Interpretation

• Several graphs may be included in the exam. These can indicate movements between different economic points:
  • Example question: Movement from point A to B can illustrate the effects of either expansionary or contractionary monetary policies.
  • Students may see variations of similar graphs depicting different scenarios (using different policy actions).

Phillips Curve Basics

• The natural rate of unemployment when inflation is stable or expected inflation is depicted on the Phillips curve. Important metrics are:
  • If inflation rises (to 15%), unemployment could temporarily decrease.
  • If inflation decreases (to 5%), the short-run unemployment rate goes up (to 7.5%).

Money Market Mechanics

• The money supply curve affects interest rates based on whether a policy is expansionary or contractionary:
  • Expansionary monetary policy shifts the money supply curve right, decreasing interest rates.
  • Contractionary monetary policy shifts the money supply curve left, increasing interest rates.

Interest Rates Impact

• Interest rate changes affect different economic sectors equally:
  • An increase in interest rates typically decreases consumption, investment, and net exports.
  • Conversely, a decrease in interest rates typically leads to increased spending in those sectors.

Fiscal Policy Challenges

• Key issues with fiscal policy include:
  • Delay in approving policy changes (both in implementation and legislation).
  • Political challenges affecting fiscal decisions.
  • Crowding out of private investment due to increased government spending.

Additional Concepts

• Commodity Money vs. Fiat Money:
  • Commodity Money: Has intrinsic value (e.g., gold, silver).
  • Fiat Money: Value is derived only as currency without inherent value.
• Hyperinflation: Defined as extraordinarily high inflation rates, typically above 50% annually.
• Federal Funds Rate: The interest rate banks charge each other for overnight loans. It is a target rate for the Fed when implementing monetary policy.

Study Focus

• Be familiar with the relationships and their implications:
  • Expansionary policies increase real GDP and the price level.
  • Contractionary policies typically decrease them.
• The Fed's monetary policy goals include:
  • Price Stability
  • High Employment
  • Economic Growth
  • Stability of Financial Markets

Conclusion

• A comprehensive review of the relationships between monetary policy, fiscal policy, interest rates, and economic indicators is essential for exam success.