Macro Final Review PDF

chapter 8 Chapter 8) Measuring Total Production and Income Gross Domestic Product - measure the country income (from one year to another) within a country border (doesn’t matter which resident) - Measured in market value “VALUE TERMS” (price times quantity of final goods) Business Cycle - alte...

chapter 8 Chapter 8) Measuring Total Production and Income Gross Domestic Product - measure the country income (from one year to another) within a country border (doesn’t matter which resident) - Measured in market value “VALUE TERMS” (price times quantity of final goods) Business Cycle - alternating periods of economic expansion and recession Expansion: Increase in income and total production Recession: Decrease in income and total production Economic Growth - the ability of an economy to produce and increase amount of good and service Inflation Rate - the percentage of price level (increase in price level = inflation) Final good and service must be already sold to consumers ex) Military weapon bought by govt/ pickup truck bought by consumers Intermediate goods are not counted it in GDP to reduce DOUBLE COUNTING (goods bought that produce a final good) ex) coffee beans sold to shop STOCK/BONDS are not part of GOODS they are money supply “Domestic” in GDP refers to within a country border “During a Period of time” refers to the goods produced in the specific year or service affiliated with that year Expenditure - total amount of money spend on good/service over time II) PART OF GDP (Expenditure measure of GDP) GDP = C+I+G+NX 1) Consumption - consumer having durable goods (car/furnitures/appliances) Non durable goods are like clothes and food - Spending on service is the largest component of consumption (service economy) - U.S has the biggest consumption rate 2) Investment - Business fixed investment (purchase of capital goods) - factories/office/machinery/research & development - Purchase of residential investment (condos/houses) - Change in inventory investment (good produced but not sold) 3) Govt Purchase - doesn't include transfer payment like social security or food stamp  - Military/ education/ infrastructure/ highways 4) Net Export (export - import) - US net export has been negative more import than exports] - export : firm sell to other country import: household buy from other country III) GNP (gross national product) - productions made by U.S resident all over the world GNP= GDP + foreign products made by U.S firm - product in the U.S made by foreign firm 1) Measuring nominal GDP of a given year = (price A x quantity A) + (price B x Quantity B) etc.. vs real GDP we use the price of base year multiply by quantity 2) Circular Flow Diagram (visual model of the economy) Amount of money you spend = amount of income you have 4 Factor of Production (Firm/ Labor/ Capital/ Entrepreneurship) Firms provides income wage/rent/profit/interest Govt take taxes from household/firm to make transfer payment to household while purchasing from an firm Financial System - firms that specifically deals with the flow of money like bank (household may save their income to these) - LEND MONEY TO FIRM/ GOVT IV) Value Added Method (marginal price) - additional market value of a firm added to a product EX) 1st Value of product =1 Value added = 1 2nd Value of product = 3 Value added = 2 3rd Value of product = 15 Value added = 12 1+2+12= 15 GDP DEFLATOR = NOMINAL GDP/REAL GDP TIMES 100 NATIONAL INCOME = GDP - depreciation GDP = National Income + Depreciation PERSONAL INCOME = national income + transfer payment - retain corporate entry DISPOSABLE PERSONAL income = personal income - personal tax SHORTCOMINGS OF GDP (what they don’t measure) 1) HOUSEHOLD PRODUCTION (childcare/cleaning/cooking/making gift to another) 2) SHADOW ECONOMY (illegal market selling illegal stuff not in part of official tax report 3) VALUE OF LEISURE (doesn’t tell if leisure affect productivity) 4) DOESN’T ACCOUNT FOR POLLUTION/ ENVIRONMENTAL DISASTER 5) CRIME/ SOCIAL PROBLEM (divorce/abortion/civil rights) 6) DISTRIBUTION of Income to social class If Nominal GDP > real GDP there is inflation chapter 9 Chapter 9) Unemployment/ Inflation 9.1) Unemployment - refers to individuals who are employable but are unable to find a job (never is zero ppl don’t find jobs instantly) Recessions - spike of unemployment - The U.S. Census Bureau conducted population survey of age 16+ - Asked about employment in reference week and recent job search 3 Categories of unemployment 1) Employed -m someone who work during most week/ temporarily away from job due to break 2) Unemployed - someone actively looking for a during a job for 4 weeks and more they are undiscouraged and don’t give up 3) Not in labor force - neither or other apply (students/ veterans/ people who wants a job but not eagerly finding one = discouraged workers Labor Force= employed + unemployed 𝑈𝑛𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 Unemployment rate = 𝐿𝑎𝑏𝑜𝑟 𝐹𝑜𝑟𝑐𝑒 (100) Unemployment rate may understate unemployment (broader orange) (discouraged worker are not counted = not in labor force/ counting part time workers looking for full time as employed) - The rate may also overstate unemployment 1) Some ppl claim unemployed might be discouraged 2) There are people who claim unemployed but employed in underground econongy 3) Claim to be unemployed to get unemployed insurance’ African American has the most unemployment rate AVG U.S. unemployment rate = 3.6 percent Working Age Population = Labor Force + not in labor force 𝐿𝑎𝑏𝑜𝑟 𝐹𝑜𝑟𝑐𝑒 Labor Force Participation rate= 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐴𝑔𝑒 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 (100) - Men is declining in labor force participation rate due to older men retiring early and younger men need more time in grad school - Women labor force is rising as there more job opportunities created as year progresses 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 Employment Population Ratio = 𝑊𝐴𝑃 (100) Full employment occur w only structural and frictional unemployment (never fall to zero) 1) Structural unemployment - persistent mismatch between skills and requirements (need retraining) like computer science major with job 2) Frictional unemployment - short term unemployment when matching worker with jobs in the process of job searching 3) Cyclical Unemployment - caused by business cycle recession (worker wouldn’t be unemployed if there was no recession) GOVT POLICIES to reduce unemployment - Sponsor job/career fair (reduce frictional unemployment) - Retraining sponsored program (reduced structural unemployment) - Increase tax credit/ subsidize new hires (reduce frictional unemployment) GOVT policy that may increase unemployment - Unemployment insurance/ payment wage to unemployment like in COVID times (increasing efficiency wage reduce employment (quantity of labor demand is less than quantity of labor supplied) - LABOR UNION for better wage also increase unemployment) - IN COVID time, there was CARE ACTS that gave 24.45 wage per hour for 40 hour in a week Job are continuously create and destroyed due to technological advancement plus consumer taste/ preference 9.4 Measuring Inflation 1) Price Level - measures the average price of good/service in the economy 2) Inflation Rate - measures the percentage increase in the price level from one year to another (as inflation rise, every dollar you own values less) Stable prices are important in making good economic decision with spending and savings Inflation is measured by tracking the prices of a basket of good (211 types of goods) CPI (consumer price index) - measure of price (inflation) of an typical family of 4 pay for the good and service purchased: cost of living index - Only focus on consumers (only predicts price change not actual price itself) (𝑃𝑋𝑄) 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑 𝑎𝑛𝑑 𝑠𝑒𝑟𝑣𝑖𝑐𝑒 𝑖𝑛 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑦𝑒𝑎𝑟 CPI = 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠/𝑠𝑒𝑟𝑣𝑖𝑐𝑒 𝑖𝑛 𝑏𝑎𝑠𝑒 𝑦𝑒𝑎𝑟 (CPI* price of base year) = price of current year 𝑁𝑒𝑤 − 𝑜𝑙𝑑 𝑝𝑟𝑖𝑐𝑒 Inflation rate = 𝑜𝑙𝑑 𝑝𝑟𝑖𝑐𝑒 (100) Price (wage) will rise as inflation rises Ones with fixed income will have less purchasing power as inflation occurs 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐻𝑜𝑢𝑟 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 Real Avg Hour Earning = 𝐶𝑃𝐼 (100) Real Interest Rate = Nominal interest rate - inflation rate Problem with anticipate inflation - Redistribution of income may fall behind for some as firms adjust in different rate - Cash loses value (people/firm increases real cost of product) - Investors are taxed on nominal returns rather than real return which increase tax dues chapter 13 13) Aggregate Demand and Supply Analysis Potential GDP = real GDP In long run NBER (National Bureau of Economic Research) is responsible for telling if were in recession or expansion “recession=decline in overall economic activities” ↓ 𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛/𝑒𝑚𝑝𝑙𝑜𝑦𝑚𝑒𝑛𝑡/𝑟𝑒𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒/ 𝑏𝑢𝑠𝑖𝑛𝑒𝑠𝑠 # Aggregate Demand Curve - relation between the price level and quantity of real GDP demanded by household/ firm/ govt SRAS - relation in short run between price level and Q of real GDP Supplied by firms Real GDP 13.1) Aggregate Demand is downward Sloping due to (Y=C+I+G+NX) 1) Wealth Effect - household wealth is hold by normal wealth (A) *When the price level falls, the real value of household wealth rise 2) ↑ 𝑃𝑟𝑖𝑐𝑒 𝐿𝑒𝑣𝑒𝑙 ↓ 𝐿𝑒𝑣𝑒𝑙 𝑜𝑓 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 3) Interest Rate Effect - household will need more money to finance if price level increase ↑ 𝑃𝑟𝑖𝑐𝑒 𝐿𝑒𝑣𝑒𝑙 ↓ 𝐿𝑒𝑣𝑒𝑙 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡  4) International Trade Effect - Export (other countries buying from U.S) become relatively more expensive if Price Level in U.S increase where domestic consumer will want cheaper foreign goods ↑ 𝑃𝑟𝑖𝑐𝑒 𝐿𝑒𝑣𝑒𝑙 𝑜𝑓 𝑈. 𝑆 ↓ 𝑁𝑒𝑡 𝐸𝑥𝑝𝑜𝑟𝑡 (↓ 𝐸𝑥𝑝𝑜𝑟𝑡 ↑ 𝐼𝑚𝑝𝑜𝑟𝑡) ↑ 𝑖𝑛𝑐𝑜𝑚𝑒 𝑜𝑓 𝑈. 𝑆 ↑ 𝐼𝑚𝑝𝑜𝑟𝑡 ↓ 𝐸𝑥𝑝𝑜𝑟𝑡 ↓ 𝑁𝑒𝑡 𝐸𝑥𝑝𝑜𝑟𝑡 ↑ 𝐸𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑟𝑎𝑡𝑒 𝑓𝑟𝑜𝑚 𝑠𝑡𝑟𝑜𝑛𝑔𝑒𝑟 𝑈𝑆𝐷 ↑ 𝑖𝑚𝑝𝑜𝑟𝑡 3 Variable Shifters of Aggregate Demand Curve 1) Changes in Govt Policy - Monetary Policy - the action that Federal Reserves to take managing the money supply through interest rate ↑ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 ↓ 𝐴𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒 𝐷𝑒𝑚𝑎𝑛𝑑 (𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑒𝑓𝑓𝑒𝑐𝑡𝑒𝑑) ↑ 𝐺𝑜𝑣𝑡 𝑇𝑎𝑥 ↓ 𝐴𝑔𝑔𝑟𝑒𝑔𝑎𝑡𝑒 𝐷𝑒𝑚𝑎𝑛𝑑 (𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑎𝑓𝑓𝑒𝑐𝑡𝑒𝑑) - Fiscal Policy - changes in federal taxes and purchase that are intended to achieve macroeconomic policy objectives ↑ 𝐺𝑜𝑣𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 (𝑒𝑥 𝑇𝑅) ↑ 𝐴𝐷 (𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡) ↑ 𝑝𝑒𝑟𝑠𝑜𝑛𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥/ 𝑏𝑢𝑠𝑖𝑛𝑒𝑠𝑠 𝑡𝑎𝑥 ↓ 𝐴𝐷(𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡) 2) Expectation of Household Firms ↑ 𝐹𝑢𝑡𝑢𝑟𝑒 𝐸𝑥𝑝𝑒𝑐𝑡𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑖𝑛𝑐𝑜𝑚𝑒/ 𝑃𝑟𝑜𝑓𝑖𝑡 ↑ 𝐴𝐷(𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛/𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡) 3) Foreign Variable Changes (income/exchange rate) ↑ 𝑔𝑟𝑜𝑤𝑡ℎ 𝑜𝑓 𝑅𝐺𝐷𝑃 𝑂𝐹 𝑈𝑆 𝑓𝑟𝑜𝑚 𝑜𝑡ℎ𝑒𝑟 𝑐𝑜𝑢𝑛𝑡𝑟𝑖𝑒𝑠 ↓ 𝐴𝐷 (𝑁𝑋 𝐷𝐸𝐶𝑅𝐸𝐴𝑆𝐸 𝐹𝑅𝑂𝑀 𝑅𝐼𝑆𝐼𝑁𝐺 𝐼𝑀𝑃𝑂𝑅𝑇𝑆) A decrease in U.S. exchange rate will increase AD ↑ 𝐸𝑥𝑐ℎ𝑎𝑛𝑔𝑒 𝑅𝑎𝑡𝑒 𝑜𝑓 𝑈𝑆𝐷 ↓ 𝑁𝑋 (𝑜𝑡ℎ𝑒𝑟 𝑐𝑜𝑢𝑛𝑡𝑟𝑖𝑒𝑠 𝑎𝑟𝑒 𝑡𝑜𝑜 𝑝𝑜𝑜𝑟) A decline in aggregate demand curve may increases sales of inferior good Inflation = change in the price level 13.2) Aggregate Supply Curve LRAS (SHIFTER) (price level don’t affect LRAS) 1) Number of Workers ↑ 𝑤𝑜𝑟𝑘𝑒𝑟𝑠 ↑ 𝐿𝑅𝐴𝑆  2) Capital Stock (goods producing other goods) ↑ 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 ↑ 𝐿𝑅𝐴𝑆 3) Technological Advancement ↑ 𝑇𝑒𝑐ℎ𝑛𝑜𝑙𝑜𝑔𝑦 ↑ 𝐿𝑅𝐴𝑆 SRAS is upward sloping 1) Price level directly increase price level of input used (increasing profit) 2) When there is change in price levels, firms are too slow to adjust their price ↑ 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 ↑ 𝑠𝑎𝑙𝑒 Three Reason Price Adjust Slowly 1) Contracts between prices and wage = “Stickiness” 2) Firms are too slow to adjust wage when theres an price change 3) Menu Cost (cost of firm to change prices) make the price sticky like general ck (firm base their price today base on what they expect their future prices will be) SRAS 5 Variable Shifter 1) Technology (direct) 2) Inflation Expectation (↑expected inflation in future ↓ 𝑆𝑅𝐴𝑆 𝑓𝑜𝑟 𝑡𝑜𝑑𝑎𝑦) 3) Number of worker or capital (direct) 4) Firms underestimating the price level (↓ 𝑆𝑅𝐴𝑆 𝑡𝑜 𝑔𝑎𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑎𝑐𝑘) 5) Unexpected increase of price Input ( (↓ 𝑆𝑅𝐴𝑆 𝑡𝑜 𝑔𝑎𝑖𝑛 𝑝𝑟𝑜𝑓𝑖𝑡 𝑏𝑎𝑐𝑘) During a recession, AD shifted to the left in short run equlibirum. To gain back long run equilibrium, AS shift to right due to decrease in workers and capital (decreasing cost of production). Vice versa for expansion (AD TO RIGHT in short run equilibrium, and the Supply shift left due to increase in production (increasing cost of productioN)  Long run equilibrium = SRAS=LRAS=AD Increase in TAX, shift AD TO THE LEFT When PL* (short run) is above original PL (there is an short run inflation) When PL* (short run) is below the original PL (short run recession) Supply Shock when there is sudden increase of input of price (there could also be demand shock too from one of the AD shifters) ↓ 𝑆𝑅𝐴𝑆 ↓ 𝑅𝐺𝐷𝑃 𝑆𝑈𝑃𝑃𝐿𝐼𝐸𝐷. ↑ 𝑆𝑅𝐴𝑆 𝑏𝑎𝑐𝑘 ( 𝑡𝑜 𝑟𝑒𝑡𝑢𝑟𝑛 𝑡𝑜 𝐿𝑜𝑛𝑔 𝑟𝑢𝑛 𝑒𝑞𝑢𝑖𝑙𝑖𝑏𝑟𝑖𝑢𝑚 (𝑓𝑖𝑟𝑚 𝑛𝑒𝑒𝑑 𝑡𝑜 𝑟𝑒𝑑𝑢𝑐𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝑤𝑎𝑔𝑒) rGDP “Cash Value” = nominal wage # of dollars firm pays Real wage = Nominal Wage/ Price Index chapter 14 4) Bank/ Money/ Federal Reserve System Conventional definition of money = general imply currency of (paper/money/coin) Economist definition of money supply = any asset accepted in payment of good/service (checking/saving account/cash/deerskin/rice). Credit cards are not money since you are repaying banks the loans Money supply started off from barter system (exchanging products with another in the old age) Inefficiency of Barter System 1) Double Coincidence of Want - increases transaction cost by exchanging consecutively for a better valuable item 2) Each goods has many prices - where there are x items there are a thousands of prices from the seller that they can get for another good 3) There is a lack of standardization - trading more items for just this one item (no equality accumulated) 4) Difficulty to accumulate one’s wealth by exchanging Four Functions of Money 1) Medium of exchange - widely accepted payment of good/ service 2) Unit of exchange - each good has one price rather than many prices 3) Store of value - Money can be stored in banks to purchase something in the future 4) Standard of deferred payment - money allows for good and service to be acquired and pay for in the future in term of money ex) Tuition What Serves as Money? Must be standardized (must be relatively same) Have durable value (must not lose value over time) Be valuable relative to weight (large enough to be useful in trade Without worrying about literal weight of it) Be divisible (different prices amongst different units of good/ easily splittable value) Must be accepted by many others 14.2) Commodity vs Fiat Money Commodity Money - has money value and other values it holds (deer skin, gold, rice) Fiat Money - govt issued paper currency not back up by physical commodity value M1 and M2 money supply (monetary aggregate) - general population (credit card is not counted nor bitcoins) Money supply example: cash/ saving/ checking account M1: currency circulation of what you have currently held by the bank (liquidity)(M1 money will increase when depositing) M1= currency + demand deposit + saving deposit M2: includes currency circulation with small denomination deposit and non institutional mutual fund share (broader definition of money supply (M2 Money supply won’t be affected when depositing) broader money supply M2 = M1 + small denomination time deposit + non institutional fund share 14.3) The roles of banks in the economy Banks play an important role in sizes of money supply (checking/ saving account) Banks sources of usage of the funds are summarized in a balance sheet of assets and liabilities Bank put some money on hold (reserve, and use some of the money to make loans/ body security) Stockholder Equity = Total Asset - Total Liability Banks makes money by lending out excess reserve (amount of money deposited not hold as reserves) Using T-Accounts to show how banks earn money Example) one consumer deposits 1000 dollars to PNC so PNC saves 1000 dollars to the checking account. However, to make money, PNC has a rule that 90 percent of deposits will be lent out. Asset Liability Reserve $ 1000 Deposit $1000 Loan $ 900 Deposit $900  Loaning out 900 dollar in excess reserve where PNC increase money supply by 900 dollars Money Supply = currency circulation + Deposit of the bank EXAMPLE 2) You deposited $5000 to Bank Of America which reserve $5000, but they have an 80% loaned out A) show initial deposit B) show wut happen after loan 3) Bank of America loans the rest to PNC A) No change in money supply when depositing to checking account Liability Asset Reserve $5000 Deposit $5000 B) Sally money is loans out 80 percent increase on it reserve (increase by 4000) Liability Asset Reserve $5000 Deposit $5000 Loan 4000 Deposit $4000 Reserve - 4000 Deposit -4000 C) Sally loaned money goes to maggie at PNC (no change in money supply) Liability Asset Reserve $4000 Deposit $4000 Interest on reserve balance - the fed no longer use money supply as monetary policy (only interest rate as monetary policy) In October 2008. The fed began paying interest on bank reserve interest rate on reserve balance (IORB) = held more reserves on banks 14.4) The Federal Reserve System In 1913, congress founded the Federal Reserve Act to improve the banking system prior to 1914 (Central bank that help prevent a bank run) - - They are Lender of Last Resorts with discounted loans (fed interest rate) Bank Run - A situation in which many depositor simultaneously decide to withdraw money from bank (more often today as money can be easily withdraw) Bank Panic - a situation when many banks experiences bank runs In 1914, Fed Started Operation by dividing two bodie through 12 Federal Reserve and board of gov districts over the U.S. each with 7 Board of Gov members that were responsible for overseeing federal reserve system for 14 years 1914 - FOMC (Fed Open Market Committee) include the 7 board plus chair repsoisble for market operation and managing money supply in U.S In 2023, Chair of Board of GOV was Jerome Jay Powell (have a renewable 4 year term) Fed didn’t help in great depression in 1929-1933 When the Federal Reserve purchases Treasury securities in the open​market, the seller of such securities deposit the funds in the bank (increasing bank reserve) When fed reserve sell treasury securities, buyers will pay with checks (decreasing fed reserve) 𝑃𝑟𝑖𝑐𝑒(𝑅𝑒𝑎𝑙 𝐺𝐷𝑃) 𝑜𝑟 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝐺𝐷𝑃 VELOCITY OF MONEY = 𝑀𝑜𝑛𝑒𝑦 𝑆𝑢𝑝𝑝𝑙𝑦 M​= Money​supply: We use M1. Velocity of​money: The average number of times each dollar in the money supply is used to purchase goods and services included in GDP. P​= Price​level:​Typically, the GDP Deflator or Price Y​= Real​output:​Typically, real GDP. Velocity rate = inflation rate when money supply and real gdp growth rate is constant Inflation rate= growth rate of money supply + velocity - growth rate of real output (rGDP) 1) If the growth rate of money supply grow faster than real output there inflation  2) If growth rate of money supply grows slower than real output there deflation 3) growth rate of the money supply determines the rate of inflation. EXAMPLE) Suppose that the Federal Reserve engages in an open market sale of ​$ 15 million in the U.S. Treasury bills to banks. In the​T-accounts for the Fed and for the banking system shown​here Federal Reserve Assets Liabilities Treasury Bills -$15mill Reserves -$15 million Banking System Assets Liabilities Treasury bills ​$15 million Reserves - ​$15 million chapter 15 Chapter 15) Monetary Policy (scarce reserve/ample reserve) The U.S central banking system was established in 1913 by Federal Reserve Act (main responsibility of Fed was to make discount loans to prevent bank panics) Great Depression occurred in 1930-33 (with peaked unemployment of 25%, wholesale plummet to 32%, (⅓) of 7000 banks failed) Fed Reserve’s monetary policy is targeted to achieve 4 goals 1) Price Stability (rising price erodes money value in exchange & stored value) 2) Max. Employment (dual mandate of the Fed = price stability + max employed) - Fed usually decrease target rate range for FFR during a recession to promote more employemnt 3) Stability of Financial Market & Institution (need to be efficient to match saver and borrowers 4) Moderate Long Term Growth (allow household and firm to plan long term investment in the economy to sustain growth) Feds can influence aggregate demand through its ability to affect interest rate short term that can mainly lead to change in the long term rate to AD - When Banks need additional reserve, they borrowed from feds at the fed fund rate (FFR) - key interest rate that the Federal Reserves focused on when conducting monetary policy (market determined rate) - FOMC (federal open market committee) announce a target using different tools - FOMC sets it target rate at the Federal Fund Rate using IORB Ample Reserve = when banks keep overmax reserve (tool: Administer Rate) Scarce Reserve = when bank keep the min reserve required (tool: OMO) Prior to 2008 (Monetary Policy: Scarce Reserves Regime with tool of OMO/ Discount Rate/ require reserve)  (IORB) Demand of reserve is downward sloping ↑ 𝐹𝐹𝑅 ↓ 𝑅𝑒𝑠𝑒𝑟𝑣𝑒 - Discount Rate (interest rate charged to banks for loan obtained) acts as the rate ceiling - IORB (interest rate of reserve hold at fed bank) act as the rate floor for demand of reserve Supply of reserve is vertical due to Reserve Requirement (minimum fund bank must hold in their vault or on deposit to Fed Fund Bank) Equilibrium FFR is when the supply intersect the downward sloping portion of Demand curve Open Market Operation - Feds buying and selling govt securities (still relevant to keep reserve ample after 2008) - Fed uses Open Market Purchase to adjust supply to the right; decrease FFR - Fed uses Open Market Sale to shift supply left; increases FFR] In 2007-2009 (great recession occurred with high price increase upon federal fund rate being around (0-0.25) that stimulated an recession with lower AD and lower investment - Banks were holding more reserves than required making IORB rate equal to FFR - Due to this, reserve became super abundant (demand being horizontal) , as shifting supply would not changed the FFR no longer (open market operation in today's value could only be guided FFR to the target) Two solutions to stimulate economic growth back on track from an zero lower bound 1) Quantitative Easing - fed policy that attempt to buy long term securities to increase AD (promote investment) where it reduced interest rate - Large increase in bank reserves over the year -  2) Forward Guidance- FOMC ensuring FFR is near zero for an prolong period to encourage consumption and investment for household and firms ↓ 𝑠ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒: ↓ 𝑙𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 II) NEW MONETARY POLICY AMPLE RESERVE SYSTEM (post 2008) When supply of reserve intersect the horizontal portion of demand curve (adjusting the administered rate) Instead Fed now can adjust the FFR, by adjusting the IORB where an increase in IORB rate increase FFR (vice versa) 1) FOMC setted a target rate for FFR 2) The fed used it tool (administered rate to guide FFR to the target) ↑ 𝐼𝑂𝑅𝐵; ↑ 𝑎𝑟𝑏𝑖𝑡𝑢𝑎𝑙 𝑜𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦: ↑ 𝐹𝐹𝑅 - Arbitrage oppurtunity is when FFR falls below IORB (banks borrow at the FFR and deposit at IORB rate to earn profit) - Increase FFR by the demand for more FFR Administered rate = interest rate set directly by feds w/o looking at the open market 1) IORB (interest on reserve balance) - interest paid on reserve balance that banks hold in their account at a fed reserve bank  - IORB is an reservation rate since it is an risk free option (banks won’t lend money less than they can earn from IORB) 2) ON RRP (overnight reverse repurchase agreement) - an overnight transaction in which fed reserve sells securities to counterparty in order of borrowing funds overnight with a promise to buy it back the next day IORB> FFR > ON RRP (true floor) - FFR is slightly below IORB due to financial institutions like government institution not allowed to hold funds from feds at the IORB rate, offering rate below IORB The ability of fed to affect real GDP depends on its ability to affect long term real interest rate Interest rate decrease, increase consumption, investment, and NX (more exports/ decrease in attraction by foreign firms to invest Expansionary (LOOSE/EASY) monetary policy occur in a recession for point (A) underproduction / employment than RGDP (reducing IORB/ FFR/ interest rate, ↑ 𝐴𝐷) Contractionary monetary (TIGHT) policy occur when economy is producing above potential GDP (overproduction) = inflation - When there is inflation, Fed Reserve increase it target rate range of FFR (increasing discount rate, IORB, ON RRP, FFR) to decrease AD back to long run equilibrium (INCREASE IORB, FFR, to interest rate to decrease AD) Effect of a poorly time Monetary Policy on the economy After an recession is over, by keeping the interest rate low for way too long after the start of expansionary policy after expansion had begun, could increase a larger inflation rate where the next recession will be more severe