Fiscal Policy and Money Supply Overview

Chapter 13: Fiscal Policy, Deficits, and Debt

  • Monetary Policy: Control of money supply

    • Contractionary: Higher interest rates, reduced money supply, lower inflation

    • Expansionary: Lower interest rates, increased money supply, higher inflation

    • The FED manages money supply.

  • Fiscal Policy: Government spending and tax management

    • Expansionary Fiscal Policy: Increased government spending and tax decreases to boost aggregate demand and real GDP.

    • Contractionary Fiscal Policy: Decreased spending and increased taxes to lower aggregate demand and control inflation.

  • Government Spending (G) & Taxes (T): Decisions depend on economic context.

    • Infrastructure needs: Increase G

    • Demand-Pull Inflation: Increase T

    • Inefficiency concerns: Decrease G in inflation; Decrease T in recession.

  • Built-In Stability: Tax system adjusts deficits; deficits increase during recessions and decrease during surpluses.

  • Cyclically Adjusted Budgets: Evaluates government finances assuming full employment; observes deficits during economic downturns.

  • Problems with Fiscal Policies:

    1. Timing issues (lags)

    2. Political influences

    3. Future policy changes

    4. State and local offsetting

    5. Crowding-out effect.

  • U.S. Public Debt: Represents federal deficits and surpluses; four types of securities:

    1. T-bills (short-term)

    2. Treasury notes (medium-term)

    3. Treasury bonds (long-term)

    4. U.S. Savings Bonds (long-term, non-marketable).

Chapter 14: Money, Banking, and Financial Institutions

  • What is Money: Accepted medium of exchange with three functions:

    • Store of value

    • Unit of account

    • Medium of exchange

  • U.S. Money Supply: M1 includes currency and checkable deposits; M2 includes near-moneys like savings accounts.

  • Purchasing Power of U.S. Dollar: V = rac{1}{P}; value decreases with rising price levels (inflation).

  • Federal Reserve Act of 1913: Established to stabilize banking system; comprises 12 regional banks.

  • Functions of the Fed:

    • Issues currency

    • Sets reserve requirements

    • Loans to financial institutions

    • Facilitates check collection

    • Supervises banks

    • Controls money supply and interest rates.

  • Control of Money Supply by the Fed:

    1. Reserve Requirement: Decrease increases supply; increase decreases supply.

    2. Discount Rate: Decrease increases supply; increase decreases supply.

    3. Open Market Operations: Buying bonds increases supply; selling decreases.

  • Full Employment Context: Characterized by no inflation gap, efficient resource use; economic equilibrium.