12 Monetary And Fiscal Policy

Question 1

Fiscal policy

Balanced, surplus, deficit

Answer 1

Spending and taxing to affect economic activity.

Balanced -> tax rev = government expenditure
Surplus - >tax rev > exp
Deficit - >gov expenditure > tax rev

Can be used to redistribute income/wealth

Question 2

Monetary policy

Answer 2

Central bank’s actions that affect quantity of money and credit to affect economy. Expansionary –> central bank increases quantity of money and credit. Contractionary is opposite.

Question 3

Money

Answer 3

Medium of exchange, Unity of account, store of value.

Question 4

Broad Money

Answer 4

Narrow money + amount in liquid assets. Narrow money is amount of currency/coin in circulation +balances in checking account.

Question 5

Money that can be created formula

Answer 5

Money created = new deposit/ reserve requirement.

Question 6

Money Multiplier

Answer 6

1/Reserve Requirement

Question 7

Quantity Theory of Money

Answer 7

Quantity of money is some proportion of total spending in economy, implies quantity equation of exchange

Question 8

Quantity equation of exchange

Answer 8

money supply * velocity = price * real output. MV = PY.

Question 9

Why monetarists think an increase in money supply leads to proportionate increase in price level.

Answer 9

They think velocity and real output change slowly, not affected by monetary variables. This is the theory of money neutrality.

Question 10

Demand for Money

Answer 10

Amount that households hold in money. 1. Transaction demand, GDP ^, transactions ^. 2. Precautionary demand. Economy size ^, precautionary ^. 3. Speculative demand, inversely related to returns in market.

Question 11

Money Supply Curve

Answer 11

Vertical and independent of interest rates.

Question 12

Interest rates in short term

Answer 12

If interest rates are above equilibrium, people will stop holding money and buy because returns are high. There was an excess supply of real money. Interest rates are below equilibrium, excess demand for real money. Firms/households will sell securities.

Question 13

Fisher Effect

Answer 13

Nominal interest rate is the sum of the real interest rate and expected inflation. RNom = RReal + E[I] - expected inflation. Add in + RP for risk premium.

Question 14

Goals of central bank

Answer 14

Supplier of currency, banker, regulator, lender of last resort, holder of gold, conductor of monetary policy.. stability in exchange rates, full exmployment, interest rates.

Question 15

Objective of central bank

Answer 15

Control inflation to promote price stability.

Question 16

Pegging

Answer 16

Other countries choose a targel level for the exchange rate of their country to that of another country’s. If their currency ^, they sell domestic currency reserves for dollar to reduce exchange rate.

Question 17

When unanticipated inflation is higher than expected

Answer 17

Borrowers gain at the expense of lenders as loan payments in the future are made with currency that has less value in real terms.

Question 18

Monetary policy tools

Answer 18

Policy rate, reserve requirements (decrease allows for more fund availability for lending, which tends to decrease interest rates), Open market operations.

Question 19

Monetary transmission mechanism

Answer 19

The way a change in monetary policy affects the price level and inflation.

Question 20

Contractionary Monetary Policy example

Answer 20

EG Short term lending rates ^, cause agg demand to decrease due to low credit purchases. Asset prices decrease as discount rates applied to future expected cash flows are increased. Decreased spending due ot poor economic expectations. Appreciation of domestic currency relative to foreign.

Question 21

Expansionary Monetary Policy example

Answer 21

1. Central bank buys securities, reserves ^. Short term and in turn long term rates decrease. Currency depreciates. Business investment ^. Increase in foreing demand for domestic goods. Agg demand ^ due to consumption, investment and net exports. Inflation, employment and real GDP ^. Asset prices ^.

Question 22

Qualities of effective central bank

Answer 22

Independence - operational and target ( they define inflation). 2. Credibility. 3. Transparency.

Question 23

Exchange rate targeting

Answer 23

If my foreign, domestic exchange value falls relative to US dollar, I use foreign reserves to purchase domestic currency (reduce money supply and increase interest rates) to reach target exchange rate.

Question 24

Neutral interest rate

Answer 24

real trend rate of economic growth + inflation target. Growth rate of the money supply that neither increases/decreases economic growth rate.

Question 25

Limitations of monetary policy

Answer 25

If peeps believe increase in money supply will reduce inflation due to higher short term rates, the expectation of inflation will cause l-term rates to fall. Vice versa. If demand for money is elastic and individuals still hold, liquidity trap. will occur even and increase in money supply won’t lower short term rates.

Question 26

Automatic Stabilizers

Answer 26

built in fiscal devices triggered by state of economy. EG during recession, tax receipts fall and unemployment pmt ^.

Question 27

Objective of fiscal policy

Answer 27

Influence level of economic activity and aggregate demand. Redistribute wealth and income. Allocate resources.

Question 28

Debt Ratio

Answer 28

Agg debt to GDP

Question 29

Why you shoul dbe concerned with size of fiscal deficit

Answer 29

1. Higher deficits lead to future taxes and dicentives to work. If mkts lose confidence in government, investors won’t refinance debt and gov could default. 3. ^ Gov borrowing ^ interest rates, and firms may reduce borrowing and investing bc gov is taking over “crowding out affect”. Gov borrowing takes over private sector.

Question 30

Spending tools (fiscal policy)

Answer 30

Transfer payment (take the tax and redistribute wealth. Ugh). Current spending - gov purchase of goods and services. Capital spending - gov spending on infrastructure.

Question 31

Revenue tools

Answer 31

Direct taxes (income/wealth taxes), indirect taxes - goods and services.

Question 32

Fiscal multiplier

Answer 32

Determines the potential increase in Agg Demand resuling from ^ in governement spending. Fiscal multiplier = 1/(1-MPC(1-t))

Question 33

Ricardian equivalence

Answer 33

^ in current deficit mean greater taxes in future. COnsumer knows this, and increase savings and reduces current consumption. Thus no effect on agg demand.

Question 34

Lags on discretionary fiscal policy

Answer 34

Recognition (policymakers take a while to recognize economic problems). Action - time gov takes to discuss, vote etc. Impact - time between enactment and when effect on economy occurs.

Question 35

Expansionary Fiscal and Monetary

Answer 35

Interest rates are low and private/public sectors expand.

Question 36

Contractionary fiscal and monetary

Answer 36

Agg demand and GSP are lower, interest rates are higher. Public/private markets contract.

Question 37

Expansionary fiscal and contractionary monetary

Answer 37

Agg demand will be higher (fiscal policy), interest rates are higher, gov spending as % of GDP ^.

Question 38

Contractionary fiscal and expansionary monetary

Answer 38

Interest rates decrease, private consumption and output ^. Gov spending as % of GDP will decrease. Private sector grows.