Comprehensive Notes on Monetary Policy, Fiscal Policy, and Trade Economics

Monetary Policy and Interest Rates

• Open Market Operations & Quantitative Easing:

  • Buying government bonds increases bank reserves.
  • More checks deposited lead to increased reserves, increasing credit supply and decreasing interest rates.
  • Federal Reserve (Fed) targets lower federal funds rate.

• Credit Supply and Inflation:

  • As lending increases, M2 (money supply indicator) also increases.
  • According to the Quantity Theory of Money, more money growth leads to more inflation.
  • Credit supply shifts up can result in long-term inflation.

Fiscal Policy and Crowding Out

• Crowding Out Effect:

  • Related to fiscal policy; when government increases transfer payments to stabilize the economy, investment spending may decrease.
  • Increased government transfers lead to less effective multiplier effects as investment spending falls.
  • Example: Increased unemployment insurance enables individuals to maintain consumption, supporting the overall economy.

• Government Borrowing:

  • Increased transfers require government borrowing, which shifts credit demand up and drives interest rates higher.
  • Higher interest rates diminish borrowing by households and businesses, a phenomenon termed crowding out.

• Credit Demand vs. Credit Supply:

  • While people may have increased savings due to transfer payments, individuals can't save from earmarked funds like SNAP or Medicaid.
  • Increased demand for credit driven by government borrowing competes with household and firm borrowing, raising interest rates.

Effects of Economic Uncertainty

• Trade War and Economic Uncertainty:
  • Uncertainty reduces effectiveness of expansionary monetary policy as banks tend to hold higher reserves rather than increase lending.
  • Due to cautious behavior, banks may avoid lending more even with increased deposits.

Manufacturing Data Analysis

• Manufacturing Output vs Employment (1980 to Great Recession):

  • Manufacturing output increased by 50%, while manufacturing employment decreased by 30% due to automation.

• Post-Great Recession Trends:

  • Manufacturing output improved post-recession but stagnated since 2016 despite initial recovery.

Economic Concepts in Policy

• Low Growth and Inflation:
  • The situation of low growth combined with inflation is known as stagflation.

Comparative Advantage and Trade

• Comparative Advantage:

  • The principle states countries benefit from trading based on their efficiencies in producing different goods.
  • Example: U.S. can produce 20,000 iPhones per year or 10 innovations, while China can produce 5,000 iPhones or 1 innovation.
  • Opportunity cost for the U.S. is 2,000 iPhones per innovation.

• Specialization and Trade Gains:

  • Through specialization and trade, both countries can potentially produce and consume more than they could in isolation.
  • U.S. has absolute advantage in both production types but should specialize based on comparative advantage.

Economic Integration and Effects

• Global Economic Integration:
  • Countries that trade with each other are less likely to engage in military conflicts.
  • Historical context: Post-WWII economic relationships were formed to prevent wars.

Tariffs and Trade Policy

• Optimal Tariffs:

  • Despite free trade advocacy, tariffs may be justified for strategic security interests or if they mitigate supply chain vulnerabilities.
  • Temporary protections can help infant industries grow before competing globally.

• Revenue Collection from Tariffs:

  • Tariffs can generate revenue when demand for goods is inelastic, yielding higher profit from taxed goods.

Current Account and Trade Balance

• Understanding Current and Financial Accounts:

  • Current account: Measures trade in goods/services, factor payments, and transfer payments (e.g., remittances).
  • Financial account: Tracks investments and capital flows into/out of a country.

• Equilibrium:

  • The current account and financial account must balance, with net exports equal to net capital outflows.
  • Government deficits often influence trade deficits more than the reverse.

Conclusion

• Upcoming Chapters:
  • Transitioning to Chapter 14 on international trade, focusing on comparative advantage and practical applications in real-world economies.
  • Expect several review and application questions in the upcoming exam.