Summary

This study guide covers fiscal policy, including government spending, tax revenue, and transfers, along with expansionary and contractionary fiscal policies and their formulas. The document discusses concepts like the multiplier effect and the effects of fiscal policy on aggregate demand.

Full Transcript

Chapter 13: Fiscal Policy => Fiscal policy is comprised of government spending and tax revenue The government funds many programs through tax revenue => Government transfers: Payments by the government to households and no goods/services are provided in return => Social insurance programs: gove...

Chapter 13: Fiscal Policy => Fiscal policy is comprised of government spending and tax revenue The government funds many programs through tax revenue => Government transfers: Payments by the government to households and no goods/services are provided in return => Social insurance programs: government programs intended to protect families against economic hardship => Social security => Medicare => Medicaid => The Affordable Care Act Sources of Tax Revenue Personal income tax (BIGGEST SOURCE OF TAX REVENUE) Social insurance tax Other taxes Corporate profit tax Government Spending: Government purchases: national defense & education are the biggest categories Government transfers GDP = C + I + G + X - IM => Government controls G and indirectly affects C and I. How? Households income are affected by taxes and transfers, business investment is affected by taxes and regulations => GOVERNMENT CAN SHIFT AD CURVE => Fiscal policy: the uses of taxes, government transfers, or government purchases of goods/services to shift the AD curve => Expansionary Fiscal Policy: fiscal policy that increases aggregate demand (provides extra fuel for economy) Increase in government purchases of goods/services Cut it taxes Increase in government transfers Expansionary policy can close a recessionary gap => Contractionary Fiscal Policy: a fiscal policy that decreases aggregate demand. A reduction in government purchases An increase in tax A reduction in government transfers => Contractionary policy can close an inflationary gap ? Can expansionary policy really work: - Critics argue that: Claim 1: government spending crowds out private spending => it’s wrong because it assumes zero-sum game and it assumes resources is always being used at full employment Claim 2: Government spending crowds out investment spending => it’s wrong because it depends upon whether the economy is depressed Claim 3: government budget deficits reduce private spending => Definition of Ricardian Equivalence? => What is the big challenge with fiscal policy? There are significant lags 1. Realize the recessionary or inflationary gap by collecting and analyzing economic data 2. Develop a plan 3. Implement the action plan THE MULTIPLIER => Multiplier idea introduced by Keynes Example: consider multiplier effect of an increase in government spending Recall: 1 / 1 - MPC (assume no tax or trade) Example: $50 billion of new government spending create in terms of change in GDP if MPC = 0.5 AGDP = EMPC AAAS - multiplier = 0 5. = 2 4 AEDP = 2x$50 = $100 billion Formulas Key Multiplier *) Govt Spending multiplier formula : 1 1 - MPC *) Transfer Muliplier : MPC t 1 - MPC * Tax meliplier - MPC 1 - MPC *) Government Spending with taxes t = tax rate 1 Calways in decimal term ( 1 - [MPC (1-t)]. *) The size of the shift in the AD line depends on type of fiscal policy the * Changes in gort purchases. have a more powerful impact than changes in taxes or transfers Automatic Stabilizers : G govt, spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and it automatically contracts when the economy expands Discretionary fiscal policy G deliberate actions by policy makers rather than rules Budget Balance * Recall Sport T G TR - - : = Ca = surplus T : tax rev ⑦ = definit TR : transfers E : gout spending , * Discretionary expansionary fiscal policy decrease budget balance *) Discretionary contractionary fiscal policy increase budget balance * Cyclically adjusted budget balance : G of the the estimate at budget balance if economy is potential output = to find , you must use budget balance formula : Sport. = T - G - TR total debt= add all budget balance for all years Chapter 14 : Money , Banking , and Fed Reserve System *) US Central Bank = Fed Reserve Bank *) 3 key entities : ① Fed Reserve board of Governors ② 12 Fed Reserve Banks ③ FedOpen market committe *) Key Vocab ① Money Q Currency in Circulation ③ Checkable bank deposits ⑦ Money Supply A) Money must function as : ① Medium of exchange ② A store of value ⑤ A unit of account *) Types of money ⑦ Commodity money ② Commodity-backed money ③ Fiat money *) Measuring Money Supply > money aggregate : an overall measure of the money supply MA and M2 are two measures of money supply = > M1 ? => M2 ? * M1 : ⑦ Travelers check ② Currency in circulation ③ Checkable bank deposits * M2 : ⑦ money market funds ② savings deposit ③ time deposits ⑦ M1 *) What banks do ? = banks are financial intermediaries that use liquid assets to finance the illiquid investments of borrowers G they also make money * How does the banking system create ? money => Financial institutions operate as part of fractional reserve banking system G bank the you deposit money when in a account , part of it bank its vaults is required to hold a in as cash and the rest as lans bank *) The problems of runs worried about the bank => as people get losing money 4 Bank the bank depositors try run : many of to withdraw their funds because they fear a bank failure * ) Bank regulations : ⑦ Deposit Insurance ② Capital Requirements ③ Reserve Requirement ④ Discount window *) Limits to Bank Regulation investment bank Shadow banks insurance companies & I hedge fund companies money market fund companies X) How banks create money : count F Liabilities Loans : $900 , 000 Deposits : $1 , 000, 000 Reserve : $100 , 000 ⑰ RR Bank Reserve ? Reserve Ratio ? Excess Reserves ? > - let's assume a bank has $1000 in excess reserve , we can this summarize effect : = 1000 + [1000x(1 - rr)] + [1000x(1 - rr)2] +... + [1000x(1 vr)"] - * Key formula an infinite series can be simplified to : $1000 ur A) Total increase A in Reserve X = money multiplier in Deposit = 1000X Ex : Deposits = $250 , 000 RR = 10 % Assets Liabilities Loan : $225 , 000 Deposit $250, : 000 RR :$25 , 000 A) The Base Monetary monetary base M1 (money - ( Checkable supply) Be a , i in currency circulation *) The Reality money multiplier in = In reality , the money multiplier is the ratio of money to the supply monetary base MSC = money supply) Money Multiplier = MB ( = monetary base) = in normal times , the money multiplier for US M1 range from 1 5 to 3 0.. leaks less money created x) More = * The Fed Reserve System The Fed Reserve is bank it a central , oversees and regulates the banking system and controls monetary base C has 12 branches around the US A) Federal Funds Market => allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves Discount RateCusually than Fedfund rate *) higher G is the rate of interest to discourage the Fed charges the borrowing from the Fed) on loans to banks ⑪ If Fed wants to inc. money supply , it will BUY T-bills ① When Fed sells T-bills : ① The reserves of buyer decrease & The amount of loans will decrease because of fewer reserves ③ The money supply will decrease * Open market operations : 4 the purchase and sales of govt. securities i) to increase supply buy. money , you govt securities , which will increase amount of reserves Chapter : 15 Monetary Policy - for money the demand Veab artificate of deposit (CD) ! : A) Short-term interest rates : G the interest rates on financial assets that mature within a month or less A) Long-term interest rates: S the interest rates on financial assets that mature in years in the future ① General Rule I the higher the interest rate , the higher the opportunity cost of holding money I the lower the interest rate, the lower the cost opportunity The demand money curve r MD (money demand) Quantity of money demand x) Money curre 4 shows the relationshiptw the quantity of money demanded and the interest rate. * Shifts in Money Demand ~ Cleftshift) ~ (right shift) r..,; Mn M3 M2 Qof money A) Shifts in Real Money Demand ① Changes in aggregate price level G higher prices money (right shift) need more I ② Changes in Real GDP G goods/services produced more I more money needed Cright shift) ③ Changes in technology ④ Changes in Institutions * How does the Fed control interest rate ? the I demand = interest rate is determined by supply of money show how the i money supply curre nominal quantity of : money supplied the Fed with by varies interest rates *) The Fed can control the money supply : G Fed chooses level assume of money supply vertical line MS r m -- H E rE- · · - MB ( Q of money ⑪ Remember that monetary policy is set by the Fed P the sets target Fed funds rate and takes appropriate open-market operations Fed Funds A) Target Rate ② Open-market purchase of T-bills Ms , MS2 v > - - · ↓ - ⑳ MD 1 M, + M2 Qof money ② open-market sale of T-bills. r MS2 Ms - ⑳ - ↑ r - & , MD, M2 < My Qofmoney *) Target vs Market - the market determines IR rate , not the Fed (the Fed adjusts the money supply to achieve its target interest rates) * Long-term interest rates Grates on bonds / loans that mature in several years. * Expansionary Monetary Policy I that aggregate demand increase monetary policy x) Contractionary Monetary Policy G monetary policy aggregate demand that reduces A) How expansionary monetary policy cycle works ⑦ Increase in money supply ② Lower the interest rate ③ Higher investment spending raises income ⑪ Higher consumer spending due to increase in income ⑤ Dendgoal : Increase agg demand. sheft AD to the right *) How contractionary monetary policy cycle works ① Decrease in money supply ② Higher interest rate ③ lower investment spending ④ lower spending consumer ⑤ End goal : decrease in agg. demand shift AD to the left * How does the Fed choose expansionary or contractionary ? = policy makers try to fight recessions , as well as ensure price stabilityi low inflation Actual GDP - Potential output gap = X 100 potential ⑪ Fedfund rate rises when the output gap rises , and falls when output gap falls ① Fed fund rate is high when inflation is high , and low when inflation is low * Taylor Rule Ex : 2 07. + 1 28 x. inflation - 1 45. x unemploy rate rate (nodecimal form ( *) Inflation Targeting PCentral banks explicit target for the inflation setting an rate and use monetary policy to hit that target *) Inflation Targeting vs. Taylor rule ⑦ Inflation forward looking targeting is (forecast inflation ( ② Taylor rule is backward looking Clook at past inflation Zero lower bound *) problem zero-lower bound Pinterest rate cannot below O without issues go causing and limiting the power of monetary policy the Fed tried > - "quantitative easing" Y (buying long-term govt bonds. = they hope that it would drive down interest rate and have expansionary effect * Money , output , and prices in Long-run ⑮ Money is neutral in long-run since it cannot alter potential output Chapter 16 : Inflation , disinflation and deflation => Money and Prices ⑪ 21st country century with highest inflation in => Argentina Al Money neutrality : G leads to what the classical model price level us or posits Real Quantity of money M nominalmoney support *) Effectiveness of Monetary Policy = if due to monetary money supply increases policy , the long-run effect is price levels increasing A) Money Supply Growth and Inflation ⑪ In general inflation , and money supply more together , especially during periods of inflation *) The cost of inflation : S what prevents a , govt from paying for its expenses by printing money ? > NOTHING Consequences : by printing , the govt supply which. increase money , leads to inflation and inflation erodes the , purchasing power of money * seigniorage the revenue generated by the govt's right to :. print money. The x) inflation tax : the reduction in the real value of money held by the public caused by inflation Inflation tax = inflation rate X money supply high & O inflation - ② people reduce real money holding ⑳to hyrion ↓ · govt increase growth ↑. G rate of money growth in supply money - ⑤ supply leads to even higher inflation ① Worst record of hyper inflation : Hungary +) Output gap Positive inflationary gap = (the actual unemployment rate is below the natural rate) t NEGATIVE Output gap = recessionary gap (the actual rate) unemployment rate is above the natural *) Okunis Law G there's predictable negative relationship btw a the output gap and the unemployment rate => arise in output gap of 1% reduces the unemployment 0 5% rate by. Predicted natural rate = - 10. 5 X output gap) unemployment of unemployment rate *) Short-run Phillips Curve G the negative short-run relationship between the and the rate unemployment rate inflation inflation rate O unemployment rate *) Short-run Phillips Gurve Shifts inflation rate ↑ O ↓ SRPC unemployment rate ① Supply shock i negative supply shock = SRPC shifts up +) positive supply shock = SRPC shifts down ① Inflation Expectations : GSRPC shifts upward by the amount of increase in expected inflation Phillips Curve *) Long-run G the relationship btw unemployment and inflation after expectations of inflation have had time to adjust H #RU non-accelerating inflation : rate of unemployment B Er.. A & E SRPC ? +) Natural Rate Hypothesis +) Deflation ? + Disinflation ?

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