question

Expansionary Monetary Policy

answer

The Federal Reserve's policy of decreasing interest rates and increasing money supply to increase real GDP

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Contractionary Monetary Policy

answer

The Federal Reserve's policy of increasing interest rates to reduce inflation

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Can the Fed eliminate recessions?

answer

There is a lag between when a monetary policy is implemented and when the effects reach households and firms. Implementing a policy too late could destabilize the economy. Since a typical recession lasts less than a year, the Fed does not want to engage in procyclical policy- they want to do the reverse which is to decrease the severity of the business cycle. Implemenitng expansionary monetary policy may actually hurt the economy.

question

Timeline of expansionary monetary policy

answer

FOMC orders expansion--> money supply increases, interest rates fall --> investment, consumption, nx increase--> AD curve shifts right--> Real GDP and price level rise

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Timeline of contractionary monetary policy

answer

FOMC orders contraction--> money supply decreases, interest rates rise--> investment, consumption, nx decrease--> AD curve shifts left--> Real GDP and price level fall, unemployment rises

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Taylor Rule

answer

Links Fed's target for the federal funds rate to economic variables

question

Taylor Rule Equation

answer

Federal Funds Rate= inflation + equilibrium + .5(inflation gap) + .5 (output gap)

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Inflation Targeting

answer

Framework for conducting monetary policy that involves the central bank announcing its target level of inflation

question

Fiscal Policy

answer

Changes in federal taxes and purchases to achieve macroeconomic policy goals

question

Monetary Policy

answer

The actions the federal reserve makes to manage money supply and interest rates

question

Automatic Stabilizers

answer

Gov't spending and taxes that automatically increase or decrease with business cycle

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Crowding Out Effect

answer

Increase in gov't purchases increases federal debt--initial increase in AD, then interest rates rise which reduces consumption--shift left

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Multiplier Effect

answer

When gov't purchases, AD can be amplified by increased consumer spending

question

Expansionary Fiscal Policy

answer

increasing gov't purchases or decreasing taxes (AD Curve shifts right)

question

Contractionary Fiscal Policy

answer

decreasing gov't purchases or increasing taxes (AD Curve shifts left)

question

Why would the gov't use contractionary fiscal policy?

answer

To reduce AD that could potentially lead to inflation, or bring Real GDP back to potential GDP

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How the gov't increases the money supply in monetary policy

answer

Order gov't purchase of U.S. Treasury Securities

question

Federal Funds Rate

answer

The interest rate banks charge each other for overnight loans. Determined by the supply and demand of reserve

question

Inflation Targeting

answer

A framework for conducting monetary policy that involves the central bank announcing its target level of inflation

question

Budget Deficit

answer

The situation in which the government's expenditures are greater than its tax revenue

question

Budget Surplus

answer

The situation in which the government's expenditures are less than tax revenue

question

Philips Curve

answer

A graph showing the short-term relationship between unemployment and inflation

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Structural Relationships

answer

A relationship that depends on the basic behavior of consumers and firms and that remains unchanged over long periods

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Natural Rate of Unemployment

answer

The unemployment rate that exists when the economy is at potential GDP (5%)

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Long-Run Philips Curve

answer

Vertical, no trade off between inflation and unemployment

question

Nonaccelerating Inflation Rate of Unemployment

answer

The unemployment rate at which the inflation rate has no tendency to increase or decrease

question

Rational Expectations

answer

Expectations formed by using all available information about an economic variable

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Real Business Cycle Models

answer

Models that focus on real rather than monetary explanations of fluctuations in real GDP

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Disinflation

answer

Significant Reduction in the inflation rate

question

Too-Big-to-Fail

answer

A policy under which the federal gov't does not allow large financial firms to fail, for fear of damaging the financial system

question

What are the four components of GDP?

answer

Consumption, investment, government purchases, and net exports

question

Aggregate Demand Curve

answer

Relationship between price level and quantity of real GDP demanded

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Short-Run Aggregate Supply Curve

answer

Short-term relationship between price level and quantity of real GDP supplied by firms

question

Price Level

answer

Measure of the average prices of goods and services in the economy

question

Inflation Rate

answer

% increase in price level from one year to the next

question

Consumer Price Index (CPI)

answer

Measure of change overtime in prices a typical urban family pays

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CPI Formula

answer

Expenditures current/ expenditures base x 100 **Use base-year quantity

question

Inflation rate from CPI

answer

Change in CPI-- (current-base)/base

question

Four reasons CPI overstates inflation

answer

1. Substitution Bias 2. Increase in Quality Bias 3. New Product Bias 4. Outlet Bias

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Nominal Interest Rate

answer

The stated interest rate on a loan

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Real Interest Rate

answer

The nominal interest rate - inflation rate

question

Rule of 70

answer

# of years Real GDP per capita to double = 70/growth rate

question

Labor Productivity

answer

The quantity of goods and services produced by one worker or one hour of work

question

Factors that determine labor productivity

answer

1. Quantity of capital per hour worked 2. Level of technology

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Capital

answer

Manufactured goods that are used to produce other goods and services

question

Potential GDP

answer

The level of real GDP attained when all firms are producing at capacity

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Financial System

answer

The system of financial markets and financial intermediaries through which firms acquire funds from households

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Financial Markets

answer

Financial securities, for example stocks and bonds, are bought and sold

question

Financial Intermediaries

answer

Firms, like banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers

question

Equation for GDP

answer

Y= C + I + G + NX

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Three Main Sources of Technological Change

answer

1. Better machinery and equipment 2. Increases in human capital (knowledge and skills) 3. Better means of organizing and managing production

question

Per-Worker Production Function

answer

Relationship between Real GDP per hour worked and capital per hour worked, holding technology constant

question

New Growth Theory

answer

Technological change is influenced by economic incentives and so is determined by the working of the market system

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Wealth Effect

answer

Effect of price level on consumption

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Interest- Rate Effect

answer

Higher price levels increase interest rate and and reduce investment, therefore reducing quantity demanded

question

International Trade Effect

answer

Effect of price level on net exports

question

Long-Run Aggregate Supply Curve

answer

Shows the relationship between price level and quantity of real GDP supplied overtime

question

Supply Shock

answer

An unexpected event that causes the short-run aggregate supply curve to shift

question

Stagflation

answer

A combination of inflation and recession, usually resulting from a supply shock

question

What causes LRAS to shift to the right?

answer

Increases in labor force and capital stock cause LRAS to shift...

question

Four functions of money

answer

1. Medium of exchange 2. Unit of account 3. Store of value 4. Standard deferred payment

question

M1

answer

1. Sum of currency in circulation 2. Checking account deposits in banks 3. Holdings of traveler's checks

question

M2

answer

1. Savings account deposits 2. Small denomination time deposits 3. Balances in money markets 4. Market funds shares

question

Reserves

answer

Deposits that a bank keeps in cash in its vault or on deposit with the federal reserve

question

Required Reserves

answer

the amount of reserves a bank is required to keep, based on checking account deposits

question

Discount loans

answer

Loans the Federal Reserve makes to banks

question

Monetary Policy

answer

Manage money supply and interest rates to pursue macroeconomic policy goals

question

Three ways to implement monetary policy

answer

1. Open Market Operations 2. Discount Policy 3. Reserve Requirements

question

Open Market Operations

answer

Buying and selling of U.S. Treasury Securities to increase money supply

question

Discount Policy

answer

Lowering discount rate makes banks more willing to take additional loans and therefore increase reserves

question

Reserve Requirements

answer

Reducing federal reserve ratio- rare because it disrupts the activities of banks

question

Quantity Theory of Money

answer

M x V = P x Y money supply times velocity of money equals price level (inflation) times real GDP

question

Using Quantity Theory of Money to find inflation

answer

inflation rate = growth rate of money supply - growth rate of real output (if velocity is constant

question

Frictional Unemployment

answer

Short-term unemployment that arises from the process of matching workers with jobs

question

Structural Unemployment

answer

Unemployment that arises from persistent mismatch between the skills of workers and the requirements of jobs (for example manual jobs--> tech jobs

question

Cyclical Unemployment

answer

Unemployment caused by a business cycle recession

question

GDP Deflator Formula

answer

nominal/real x100

question

Unemployment Rate

answer

# unemployed/ # in labor force

question

Problems with unemployment

answer

1. Unemployed vs not in labor force 2. Discouraged workers not considered unemployed

question

Property rights

answer

Government aids economic growth by protecting contracts between private individuals--development of financial system

question

S(private)

answer

Y+TR-C-T (TR= transfer payments, T= taxes)

question

S(public)

answer

T-G-TR

question

S= S(private) + S(public)

answer

S= Y-C-G or S= I

question

Market for Loanable Funds

answer

The interaction between borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged

question

Inflation Rate from Quantity Theory of Money

answer

inflation rate = %ΔM - %ΔY

question

Deadweight loss

answer

Reduction of economic surplus resulting from market not being at equilibrium

question

Price ceiling

answer

Legally determined maximum price (always set below equilibrium)

question

Price floor

answer

Legally determined minimum price (always set above equilibrium)

question

Law of Comparative Advantage

answer

The ability of an individual, firm, or country to produce a good at a lower opportunity cost than competitors

question

Absolute Advantage

answer

The ability of an individual, firm, or country to produce more of a good with the same available resources

question

Free Market

answer

A market with few government restrictions on how a good or service can be produced or sold or how a factor of production can be employed

question

Schumpeter

answer

The key to rising living standards is creating new products--to revolutionize patterns of production

question

Marx Theory

answer

Labor is imperative in the development of an economy--he believed capitalism was unstable--wrong

question

Malthus Theory

answer

As population increases, food supply decreases--> famine, black death, etc

question

Keynes Theory

answer

Our economy is not flexible with wages and prices (they are "sticky"). Need to balance GDP with gov't spending if investment falls

question

Friedman Theory

answer

Free-market capitalism, people aren't always rational

question

Hayek Theory

answer

Booms and busts due to private investment, not gov't spending (animal spirits)

question

Smith Theory

answer

Division of labor/specialization--"invisible hand" promotes an unintentional end

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