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Principle of economics > CH 13+14+15 > Flashcards

CH 13+14+15 Flashcards

1
Q

taxes (definition)

A

required payments to the government

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2
Q

social insurance (definition)

A

government programs intended to protect families against economic hardship–> include social security, medicare, medicaid and the ACA and smaller programs like unemployment insurance+food stamps

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3
Q

disposable income (definition)

A

the total income households have available to spend, which is equal to the total income received from wages, dividends, interest, rent, minus taxes plus governnment transfers

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4
Q

an increase in taxes/reduction in government transfers…

A

reduces disposable income–> leaidng to fall in consumer spending

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5
Q

decrease in taxes/increase of government transfers…

A

increase disposable income–> increase consumer spending

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6
Q

why can the government shift the AD curve?

A

because the government itself is already one source of the spending that makes up the GDP (remember the formula;) )

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7
Q

government fiscal policy that closes recessionary gap:

A

expansionary fiscal policy

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8
Q

expansionary fiscal policy (definition) and its 3 forms

A

fiscal policy that increases aggregate demand by…

  1. increase in government purchases G+S
  2. cut in taxes
  3. increase in government transfers
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9
Q

fiscal policy that closes inflationary gap:

A

contractionary fiscal policy

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10
Q

contractionary fiscal policy (definition) and its 3 forms:

A

a fiscal policy that reduces aggregate demand by…

  1. reduction in government purchases G+S
  2. increase in taxes
  3. reduction government transfers
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11
Q

3 main arguments against use of expansionary fiscal policy:

A
  1. government spending always crowds out private spending
  2. government spending always crowds out private investment spending
  3. ricardian equivalence: government budget deficits lead to reduced private spending
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12
Q

ricardian equivalence (definition)

A

other things equal, expansionary fiscal policy leads to larger budget deficit+greater government debt–> higher debt eventually leads to government needing to raise taxes to pay for its debt–> consumers anticipating that must apy higher taxes in future will cut their spending in order to save money

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13
Q

one key reason for caution fiscal policy (definition+explanation)

A

there are important time lags between when policy is decided upon and when it is implemented

3 things that have to hapen before government increases spending to fighht recession:
1. has to realise that the recessionary gap exists–> economic date takes time to collect and analyse–> recessions recognised only months after have begun
2. government has to develop a spending plan–> can take months
3. takes time to spend the money

–> because time lags, might implement expansionary policy when economy already recovered and even in inflationary gap–> in that case expansionary policy will only worsen economy

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14
Q

multiplier (definition)

A

ratio of change i real GDP caused by an autonomous change (like government spending) in aggregate spending to the size of that autonomous change

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15
Q

MPC (definition)

A

marginal propensity to consume
–> the fraction of an additional dollar in disposable income that is spent

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16
Q

MPC (equation)

A

change in consumer spending : disposable income

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17
Q

fiscal multiplier Tax/Government transfer (equation)

A

MPC X 1 : (1–MPC)

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18
Q

government expenditure fiscal multiplier (equation)

A

1 : (1–MPC)

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19
Q

lump-sum taxes (definition)

A

taxes that don’t depend on the taxpayer’s income
–> with lump-sum taxes there’s no change in the multiplier

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20
Q

effect of taxes on multiplier: (explanation)

A

change size of multiplier–> because great majority of tax revenue dependent on level of economic growth (GDP) –> therefore taxes reduce the multiplier because governments holds in part of the increae in real GDP

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21
Q

automatic stabilisers (definition)

A

government spending and taxation rules that cause fiiscal poolicy to be automatically expansionary when economy contracts and automatically contractionary when economy expands

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22
Q

discretionary fiscal policy (definition)

A

fiscal policy that is the direct result of deliberate actions by policy makers rather than automatic adjustment
–> example: government during recession passing legislation that cuts taxes+increases government spending in order to stimulate economy–> in general economists only support discretionary fiscal policy in case of severe recession or sustained economic weakness

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23
Q

austerity (definition)

A

sharp cuts in spending+tax increases for economy
–> austerity is form of contractionary policy

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24
Q

expansionary fiscal policy and has the following effect on the budget balance…

A

it reduces the budget balance–> makes budget surplus smaller, or even budget deficit bigger

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25
Q

contractionary fiscal policy and has the following effect on the budget balance…

A

increases the budget balance for that year–> makes budget surplus bigger, or budget deficit smaller

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26
Q

2 reasons why can’t just use budget balance to measure fiscal policy:

A
  1. there are 2 different changes in fiscal policy that have equal effect on the budget balance, but that may have quite unequal effects on the actual economy–> changes in government purchases have larger effect on real GDP than equal sized chages in taxes+government transfers
  2. often changes in budget balance are the result, not the cause of fluctuations in the economy
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27
Q

cyclically adjusted business cycle (definition)

A

an estimate of what the budget balance would be if real GDP were exactly equal to potential output
–> takes into account extra tax revenue government would collect and transfers it would save if a recessionary gap were eliminated OR the revenue government would lose+extra transfers it would make if inflationary gap was to be eliminated

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28
Q

government deficit (definition)

A

difference between amount government spends and recieves in taxes over given period 9usually 1 year)

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29
Q

government debt (definition)

A

sum of money governmenyt owes at particular point in time

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30
Q

fiscal year (definition)

A

runs from October 1st to September 30th and is labelled according to the calender year in which it ends

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31
Q

public debt (definition)

A

government debt held by individuals and institutions outside the government–> a government that runs persistent budget deficits will experience a rising level of public

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32
Q

Potential dangers posed by Rising Government Debt

A
  1. crowding out
  2. financial pressure on future government budgets and default
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33
Q

debt spiral (definition)

A

takes place when interest rate on government debt drives that up even higher

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34
Q

debt-GDP ratio (definition)

A

government’s debt as a percentage of GDP

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35
Q

implicit liabilities (definition)

A

spending promises mady by governments that are effectively a debt despite the fact that they are not in usual debt statistics
–> implicit liabilities in US mainly arise form transfer programs aimed at providing security in retirement+protection from large health care bills

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36
Q

dedicated taxes (definition)

A

social security+part medicare supported by dedicated taxes: expenses paid out of special taxes on wages

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37
Q

money (definition)

A

any asset that can easily be used to purchase G+S

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38
Q

currency in circulation (definition)

A

cash held by the public
–> is considered money–> includes checkable bank deposits

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39
Q

money supply (definition)

A

the total value of financial assets in the economy that are considered money

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40
Q

3 roles of money (definition)

A
  1. medium of exchange
  2. store of value
  3. unit of account
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41
Q

medium of exchange (explanation)

A

an asset that individuals acquire for the purpose of trading G+S rather than for their own consumption
–> however during economic turmoil people often turn to other countries’ money as medium of exchange

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42
Q

store of value (explanation)

A

to act as medium of exchange money must also hold purchasing power over time
–> if used eg ice cream instead of money–> wouldn’t work because would melt thus no store of value

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43
Q

unit of account (explanation)

A

a measure used to set prices and make economic calculations
–> makes things lot easier–> without commonly accepted measure the terms of a transaction harder to determine–> makes it harder to make transactions and achieve gains from trade

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44
Q

commodity money (definition)

A

a good used as medium of exchange that has intrinsic value in other uses
–> gold, silver

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45
Q

commodity backed money (definition)

A

a medium of exchange with no intrinsic value whose ultimate value is guaranteed by promise that can be converted into valuable goods
–> like money notes–> could exchange that in bank for actual gold/silver coins

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46
Q

fiat money (definition)

A

a medium of exchange whose value derives entirely from its official status as a means of payment
–> like our current money

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47
Q

2 major advantages of using fiat money over commodity-backed money:

A
  1. creating fiat money doesn’t use up any real resources beyond the paper it’s printed on–> like gold/silver
  2. the supply of money can be adjusted based on the needs of the economy, instead of being determined by amount of gold/silver that needs to be found/mined
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48
Q

2 major risks of using Fiat money:

A
  1. counterfeited money
  2. governments that can create money whenever they like (because large influence within CB), will be very tempted to make use of that privilege
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49
Q

monetary aggregates (definition)

A

an overall measure of the money supply

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50
Q

3 sizes of measuring money supply: (definition)

A
  1. M1: narrowest definition
  2. M2: less narrow
  3. M3: broadest definition
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51
Q

M1 (explanation)

A

contains only currency in circulation (cash) and checkable bank deposits
–> themost liquid measure of money, because directly usable as medium of exchange

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52
Q

M2 (explanation)

A

adds several kinds of assets–> near-moneys

53
Q

near moneys (definition)

A

financial assets that can’t be directly used as medium of exchange, but can readily be converted into cash/checkable bank deposits

54
Q

M3 (explanation)

A

broad money–> includes:
- currency
- deposits with an agreed maturity of up to two years
- deposits redeemable at notice of up to 3 months
- repurchase agreements
- money market fund shares/units
- debt securities up to 2 years

55
Q

what is never part of the money supply?

A

financial assets like stocks and bonds–> because not liquid enough

56
Q

bank reserves (definition)

A

the currency bank holds in their vaults plus their deposits at the central bank
–> NOT part of currency in circulation because are not held by the public

57
Q

T-account (definition)

A

tool for analysing a business financial position by showing, in a single table, the business’s assets (on left) and liabilities (on right)

58
Q

reserve ratio (definition)

A

the fraction of bank deposits that bank holds as reserves
–> CB sets minimum required reserve ratio bank must maintain

59
Q

bank failure (definition)

A

bank unable to pay of its depositors in full

60
Q

bank run (definition)

A

a phenomenon in which many of bank’s depositors try to withdraw their funds due to fears of bank failure
–> historically proven contagious–> run on one bank leads to loss in faith in other banks–> causing additional bank runs
–> in response to bank runs 1930s–> most modern governments established a system of bank regulations that protect depositors+prevent most bank runs

61
Q

4 main feutures system of bank regulation: (definition)

A
  1. deposit insurance
  2. capital requirements
  3. reserve requirements
  4. discount window
62
Q

deposit insurance (explanation)

A

guarantees that bank depositor’s will be paid even if the bank can’t come up with the funds, up to a maximym amount per account
–> doesn’t just protect depositors if bank fails–> also greatly reduces risk for bank runs

63
Q

capital requirements (explanation)

A

because of deposit insurance–> depositors no incentive to monitor bank’s financial health–> allowing risky behaviour banks to go undetected–> owners bank incentive to engage in overly risky investment behaviour–> because if all goes well, owners profit and it goes wrong government covers losses through federal deposit insurance

–> to reduce this incentive of excess risk taking–> regulators require bank owners hold substantially more assets than value of bank deposits

64
Q

bank capital/capital/owner’s equity (definition)

A

the excess of a bank’s assets over its bank deposits+other liabilities

65
Q

reserve requirements (explanation)

A

rules set by CB that determine the minimum reserve ratio for banks

66
Q

the discount window (explanation)

A

an arrangement in which the central bank stands ready to lend money to banks in trouble
–> ability to borrow money means bank can avoid being forced to sell its assets at fire-sale prices in order to satisfy the demands of a sudden rush of depositors demanding cahs–> can run to CB and borrow funds it needs to pay off depositors

67
Q

2 ways bank affect the money supply:

A
  1. bank reduce the money supply by removing some currency from circulation–> money in bank vaults are NOT part of money supply
  2. banks increase the money supply by making loans
68
Q

money leaking out of banking system (explanation)

A

some of loaned funds don’t end up being spent/deposited immediately–> end up in borrowers wallet–> reduce size of real GDP multiplier

69
Q

excess reserves (definition)

A

a bank’s reserves over and above its required reserve
–> if bank has excess reserves–> loans it out–> that money will end up in deposit account in banking systems–> launching money multiplier process

70
Q

What does the Central Bank control:

A
  • the sum of bank reserves
  • the monetary base
71
Q

monetary base (definition)

A

the sum of currency in circulation and bank reserves

72
Q

2 ways monetary base different from money supply:

A
  1. bank reserves (part of monetary base) NOT part of money supply –> because not available for spending
  2. checkable bank deposits NOT part of monetary base–> because part of money supply and immediately available for spending
73
Q

money multiplier (definition)

A

the ratio of the money supply to the monetary base

74
Q

money multiplier (equation)

A

1: reserve ratio
–> eg if reserve ratio is 5%–> 1:0,05–> multiplier is 20–> if deposit 1m in bank the max that can be created is 20mill with that 5% reserve ratio

75
Q

Central Bank (definition)

A

an institution that oversees and regulates the banking system and controls the monetary base

76
Q

3 main policy tools fed can use (definition)

A
  1. reserve requirements
  2. discount rate
  3. open market operations
77
Q

federal funds market (definition)

A

allows that banks that fall short of reserve requirements to borrow funds from banks with excess reserves
–> interest rate in this market in this market determined by S+D–> but S+D for bank reserves is strongly affected by CB actions

78
Q

federal funds rate (definition)

A

the interest rate at which funds are borrowed and lent in the federal funds market

79
Q

discount rate (definition)

A

the rate of interest CB charges on loans to banks via discount window
–> normally set 1 percentage point higher than federal funds rate–> to discourage banks from turning to Fed when in need of reserves

80
Q

What can Fed do to alter money supply (apart from more printing):

A
  • changes in reserve requirements
  • changes in spread between discount rate and federal funds rate
81
Q

if CB reduces reserve requirements…

A

bank will lend larger % of their deposits–> increase in money supply via money multiplier

82
Q

if CB increases reserve requirements…

A

bakn forced to reduce their lending–> fall in money supply via money multiplier

83
Q

if CB reduces spread between discount rate and federal funds rate…

A

cost to banks for being short of reserves falls–> banks increase their lending–> money supply increases via money multiplier

84
Q

if CB increases spread between discount rate and federal funds rate…

A

bank lending falls–> fall in money supply via money multiplier

85
Q

open-market operation (definition)

A

a purchase or sale of government debt by CB
–> but CB never buys treasury bills never directly from government–> via commercial banks

86
Q

if CB buys treasury bill from commercial bank…

A
  • commercial banks will use that money to lend out
  • launches money multiplier
  • thus buying treasury bills from banks creates increase in both monetary base and after while in money supply
87
Q

if CB sells treasury bills to commercial bank

A
  • bank reserves fall because spent money on buying treasury bill–> fall in monetary base
  • requires banking to reduce their loans
  • leading to fall in money supply
88
Q

commercial bank (definition)

A

accepts deposits and is covered by deposit insurance

89
Q

investment bank (definition)

A

trades in financial assets and does NOT accept deposits, so it’s not covered by deposit insurance

90
Q

savings and loan (thrift) (definition)

A

another type of deposit-taking bank–> usually specialised in issuing home loans

91
Q

shadow banking (definition)

A

bank-like activities undertaken by nondepository financial firms such as investment funds and hedge funds–> without regulatory oversightor protection
–> involves financial intermediaries–> borrow short-term and use borrowed funds to buy relatively illiquid assets to put up as colleteral

92
Q

opportunity cost of holding cash money:

A

you don’t gain any interest on cash, so you pay for the convenience of holding cash that you forego the opportunity to gain extra money when you put it in the bank

93
Q

certificate of deposit/CD (definition)

A

bank issues asset in which customer deposit funds for specified amount of time and earns a specific interest rate
–> CD also carries penalties if funds are withdrawn before specified amount of time has elapsed

94
Q

short term interest rate (definition)

A

the interest rates on financial assets that mature within less than a year

95
Q

the higher the short-term interest rate…

A

the higher the opportunity cost of holding money in cash

96
Q

the lower the short-term interest rate…

A

the lower the opportunity cost of holding the money in cash…

97
Q

why do all short term interest rates tend to move together?

A
  • any ST asset that offers lower than average interest rate will be sold by investors–> move their wealth to higher yielding short-term assets–> selling of the asset forces its interest rate up–> because investors must be rewarded with a higher interest rate in order to induce them to buy it
  • investors will move their wealth into any ST financial asset that offers an above average interest rate–> purchase of asset drives interest rate down when sellers find out can lower rate of return on asset and still find willing buyers
98
Q

long term interest rates (definition)

A

interest rates on financial assets that mature a number of years in the future
–> at any given moment may be different from short term interest rates

99
Q

which rate affects the money demand? ST or LT?

A

short term–> because decision to hold money involve strading off the convenience of holding cash versus payoff from holding assets that mature in the short term

100
Q

money demand curve (definition)

A

shows the relationship between the interest rate and the quantity of money demanded

101
Q

why is the money demand curve downward sloping?

A

because other things equal,
- a higher interest rate increases the opportunity cost of holding money–> leading to public reducing the quantity of money it demands
- a lower interest rate–> reduces opportunity cost of holding money–> increases the quantity of money demanded

102
Q

4 most important factors causing shift of money demand curve: (definition)

A

(ARCI)
1. changes in Aggregate price level
2. changes in Real GDP
3. changes in Credit markets and banking technology
4. changes in Institutions

103
Q

changes in aggregate price level (explanation)

A
  • other things equal, higher prices increase the demand for money–> R shift MD curve
  • other things equal, lower prices decrease the demand for money–> L shift MD curve

THE DEMAND FOR MONEY IS PROPORTIONAL TO THE PRICE LEVEL–> if aggregate price level rises 20%–> quantity of money demanded rises by 20%

104
Q

changes in real GDP (explanation)

A

households+firms hold money to fascilitate purchases G+S–> larger quantity of G+S they buy, larger quantity of money will want to hold at any given interest rate

  • increase real GDP–> R shift MD
  • decrease real GDP–> L shift MD
105
Q

changes in Credit Markets and Banking technology (explanation)

A

need for cash money seriously reduced by series of innovations–> think of now being able to pay with your phone–> resulting in L shift MD curve

106
Q

changes in institutions (explanation)

A

for example: before 1980: no interest rates checking accounts US–> so holding money in checking accounts had opportunity cost of foregoing interest rate could get if money was in savings
–> when changed and was interest rate on checking accounts–> shift MD R because demand for money rose

107
Q

liquidity preference model of the interest rate (definition)

A

accoridng to this, the interestrate is determined by supply+demand for money

108
Q

money supply curve (definition)

A

shows how the quantity of money supplied varies with the interest rate

109
Q

MS curve is straight vertical line because…

A

the money supply is chosen by the Fed–> therefore not influenced by the interest rate

110
Q

why does demand for money eventually end up at equilibrium?

A
  • if demand is bigger than supply–> quantity of interest bearing non-money assets demanded less than supplied–> so sellers of these assets have to offer higher interest rate to attract buyers–> interest rate driven up until public wants to hold money that is actually available;
  • if demand of money is lower than supplied–> quantity of interest bearing non-money assets demanded is greater than quantity supplied–> sellers of these assets find that even if lower interest rates can find more buyers–> interest rate goes down until amount of money demanded is same as money supplied
111
Q

an increase in the money supply…

A

leads to decrease in interest rate

112
Q

decrease in money supply…

A

leads to rise in interest rate

113
Q

how can CB set the interest rate?

A

by adjusting the money supply either up/down

114
Q

target federal funds rate (definition)

A

the CB desired federal funds rate

115
Q

how can CB increase money supply to reach target funds rate?

A

by open-market purchase of treasury bill–> increases money supply because banks more money to lend out–> money multiplier effect–> this increase in money supply leads to lower interest rate

116
Q

how can CB decrease money supply to reach target federal funds rate?

A

by making an open market sale of treasury bill–> decreases money supply because banks pay money to fed which goes into vault–> decrease in money supply leads to higher interest rate

117
Q

expansionary/loose monetary policy (definition)

A

monetary policy that increases aggregate demand

118
Q

contractionary/tight monetary policy (definition)

A

monetary policy that decreases aggregate demand

119
Q

5 steps of expansionary monetary policy:

A
  1. fends wants to increase money supply
  2. so reduces interest rates
  3. lower interest rates, lead, other things equal, to more investment spending
  4. through multiplier process+increase in aggregate output demanded–> higher consumer spending
  5. in end: total quantity of G+S demanded at any given price level rises when quantity of money increases–> AD curve shifts to R
120
Q

5 steps of contractionary monetary policy:

A
  1. fed wants to contract money supply
  2. therefore increases interest rates
  3. lowers consumer spending
  4. decrease in aggregate output demanded
  5. quantity of G+S demanded falls when money supply is reduced–> AD curve shifts to L
121
Q

taylor rule for monetary policy (definition)

A

guideline used by CBs–> measures inflation, output gaps, and unemployment in order to set the interest rate

122
Q

inflation targeting (definition)

A

occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target
–> some set specific rate, other set target range–> but not much of a difference–> ones with range target for the middle, and one with specific rate have some wiggle room

123
Q

the major difference between inflation targeting+taylor rule method:

A
  • inflation targeting–> foreward looking–> forecast of future inflation
  • taylor rule method–> adjust monetary policy in response to PAST inflation
124
Q

2 key advantages of inflation targeting over taylor rule according to advocates:

A
  • transparency–> economic uncertainty is reduced because CB plan is transparent: public knows the objective of an inflation targeting bank
  • accountability–> central bank’s succes can be judged by seeing how closely actual inflation rates have matched the inflation target–> holding central bankers accountable
125
Q

critic on inflation targeting:

A

too restrictive–> times when other concerns (like stability of financial system) should take priority over any particular inflation rate

126
Q

zero lower bound problem for interest rates (definition)

A

interest rates can’t fall much below zero without causing significant problems

127
Q

running up against zero lower bound (explanation)

A

if economy in recession–> and interest rates are very low–> expansionary policy less room to operate because ST interest rates already near 0–> can’t decrease interest even further to stimulate money spending

128
Q

monetary neutrality (definition)

A

changes in the money supply have no real effects on the economy
–> in LR only effect of increase/decrease in money supply is to raise/reduce aggregate price level by an equal percentage

129
Q

why do changes in the money supply don’t affect the interest rate in the Lr?

A
  • increase in money supply (shift MS R) lowers interest rate in SR
  • but in LR higher prices lead to greater money demand–> shifting MD to R–> back to same interest rate

Principle of economics (7 decks)

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