08 - Countercyclical Policy Flashcards
Countercyclical policies attempt to….
- reduce the intensity of economic fluctuations and smooth the growth rates of employment and GDP
Expansionary monetary policy increases…. and decreases….
Contradictionary monetary policy, however,…
- bank reserves
- interest rates
- does the opposite (decrease bank reserves and increase interest rates)
Monetary policy is limited by….
… keeping inflation in a reasonable range
Expansionary fiscal policy…
Contradictionary fiscal policy, however, …..
- increases government expenditure and/ or decreases taxes
- does the opposite
Fiscal policy is limited by….
… keeping government budget deficits and debt in a reasonable range
To fight a recession, a central bank can conduct… which means…
- expansionary monetary policy, i.e. it increases the quantity of bank reserves causing short term interest rates to fall
What happens if Fed decides to lower short term interest rates and expands access to credit?
1.
2.
3.
- long term interest rates fall
- consumption and investment rises; demand for goods and services rises
- labor demand curve shifts to the right
A rightward shift of the supply curve of reserves leads to….
a reduction in the Federak Funds Rate
Recap: What are the tools of a Central Bank?
1.
2.
3.
- open market operations
- minimum reserve requirement regulations
- quantiative easinf (QE)
From the quantity theory of money it follows that, in the long-run, the inflation rate will…
Therefore, excessive growth of money supply risks…
equal the growth rate of money supply minus the growth rate of real GDP
high levels of inflation
If a central bank sees a risk of inflation relevant above its target, it usually implements a….
contractive monetary policy (such as reducing bank reserves)
Why does increasing bank reserves also increase the risk of inflation? What can central banks do?
- more reserves, more bank loans, more bank deposits M2
- start contractive monetary policy when prices start to rise beyond certain levels
What are some things that might determine whether we will be stuck in inflation in Germany?
- monetary policy
- fiscal policy
- demographic change
- greenflation / CO2 pricing
- deglobalisation
- higher wages pushed due to inflation and skilled labor shortages
If the central bank does not fight inflation, governments may try to…
What are disadvantages of this?
1.
2.
3.
4.
What could be alternatives?
1.
2.
3.
- do this using price controls
- e.g. gas price ceiling, electricity max in france
Disadvantages:
- rationing/ black markets
- wrong signal of whats scarce
- more interventions
- exports to countries paying higher prices
Alternatives:
- repair world markets
- reduce taxes
- increase transfers
Fighting inflation can only be done by the central banks
The most serious danger to central banks and classic fiat money is…
…. people looking for alternatives, such as gold, houses/ flats, crypto
What are characteristics of non convertible electronic currencies?
1.
2.
3.
4.
- claim to be trustworthy
- electronis without requiring physical presence of seller and payer
- kind of anonymous like cash (without needing a middleman like a bank who needs to be trusted, but blockchain allowing saving all transactions decentrally)
- limited in supply technically, e.g. bitcoin
What are some hypothesis on the future of money discussed among economics?
1.
2.
3.
4.
5.
6.
- cash further loses relevance and may vanish completely
- central banks introduce CBDCs to secure their influence
- functions of money (medium of exchange, unit of account, store of value) disintegrate and are fulfilled by different types of money
- people have different tyoes of money in their apps/ wallet and use them for different purposes - currency competition becomes more relevant
- big tech becomes even more powerful (e.g. establishing own currencies linked to certain services)
- digital currency unions emerge (brunnermeier et al) which may become a threat to some sovereign currencies
What are the types of fiscal policy?
1.
2.
- expansionary fiscal policy: uses higher government expenditure and lower taxes to increase the growth rate of real GDP (like expansionary monetary policy, labor demand is shifted to the right)
- contractionary fiscal policy: uses lower government expenditure and higher taxes to reduce the growth rate of real GDP (like with monetary policy, labor demand is shifted to the left)
What are the two ways fiscal policy can occur?
1.
2.
- automatically, i.e. automatic stabilizers (countercyclical components of the government budget that automatically partially offset economic fluctuations (such as falling tax collection or rising unemployment benefits during a recession)
- discretionary countercyclical components by governemnt (aspects of fiscal policy that policymakers deliberately enact in response to economic fluctuations (such as specific expenditure increases or tax cuts)
Expenditure Based Fiscal Policy | What is crowding out?
- increasing government expenditure may partially or fully displace household or firms expednitures
- influence on effectiveness of fiscal policy
The value of the government expedniture multiplier depends a lot on…
whether the economy is already at full capacity utilization (in which case crowding out will be strong and the multiplier will be close to zero)
What is something to keep in mind about the effect of tax based fiscal policy?
1.
2.
3.
- in case of a tax cut consumers may actually decide not to spend the full amount since:
- consumption has diminishing marginal returns and consumers may save part of the saved taxes for the future
- consumers relaize that at some point in the future the government will have to raise taxes again (to make up for todays loss in tax revenues) and save for this point in the future
What are some problems arising with fiscal policy?
1.
2.
3.
4.
5.
6.
- permanent deficits: at some point, the government has to pay back for expenditure increases or tax cuts. this is often hard to do politically which then results in large deficits being maintained over long periods of time
- government waste: the efficiency of government spending quickly detoriates when a lot of additional money has to be spent quickly (projects with highest social retunrs have typically been funded already)
- zombie firms: government money may artifically keep alive firms without a viable business model
- inefficient lobbying
- pork barrel spending
- implementation lags
problems arising with fiscal policy | inefficient lobbying
with a lot of government money injected into the economy, incentives for companies to maintain huge (inefficient) lobbying departments fighting for this money become larger
problems arising with fiscal policy | pork barrel spending
an individual politician has strong incentives to get a lot of (potentially inefficient) spending to his own district (at the cost of all voters in the country)
problems arising with fiscal policy | implementation lags
the money may in fact only be spent when the recession is almost over again since spending money just takes a lot of time (less of a problem with tax based fiscal policy where consumers can spend the money immediately if they want)
Discretionary fiscal policy is conducted by…
the government.it decides on government expenditure and tex levels
Rising inflation may cause the central bank to conduct…
contractionary monetary policy
Reminder: What are the tools of central bank again?
1.
2.
3.
- open market operations (influencing bank reserves and short term interest rates eg refinancing rate in Euro Area)
- minimum reserve requirement (regulations regarding the minimum reserves the central bank expects the private banks to hold)
- quantitative easing (QE) (special type of open market operations where central bank also bus longer term and potentially riskier assets)
The government expenditure multiplier is….
the X EUR change in GDP resulting from a 1 EUR change in government expenditures
between 0 and 1.5
value depends on whether economy is already at full capacity utilization (in which case crowding out will be strong and the multiplier will be close to zero)
the government taxation multiplier is the….
X EUR change in GDP resulting from a 1 EUR change in taxation
between 0 and 2
In which case will crowding out be strong?
when the economy is already at full capacity utilization (next to crowding out the multiplier will be close to zero)
