Chapter 16

Question 1

what is meant by stabilization policy

Answer 1

when the govt attempts to stabilize economy after economic fluctuations by influencing demand and thus the level of GDP, prices, unemployment and inflation, in the short run

Question 2

What is the difference between discretionary and automatic stabilization?

Answer 2

Discretionary is when action is take by the president and congress with fiscal policy. Automatic is when no action is taken and it is done by the federal reserve, open market committee with monetary policy

Question 3

what are the goals of expansionary policy

Answer 3

• intentional increase in AD
• Increase output and price level
• decrease unemployment
• done when output and inflation is low

Question 4

what are the goals of contractionary policy

Answer 4

• intentional decrease in AD
• done when output is above natural rate or unemployment is above natural rate
• done when inflation is rising

Question 5

what is meant by the FFR

Answer 5

Federal funds rate. Interest rates that banks pay to borrow reserves from each other. Most other interest rates are tied to the FFR

Question 6

How does the Fed influence the FFR

Answer 6

• interest on reserves
• overnight reserve repurchases agreement facility (rate paid by the fed to non member banks)
• discount window, rate to borrow from fed
• open market operations

Question 7

what is monetary policy used for

Answer 7

to reduce fluctuations in the economy in the short run

Question 8

How do you accomplish a lower target FFR

Answer 8

• decrease IORB (interest on required balances(reserves))
  -decrease discount rate or buy bonds
• this increases MS, C, I, AD
• this decreases r

Question 9

how do you accomplish a higher target FFR

Answer 9

• increase IORB (interest on required balances(reserves))
• increase discount rate (rate it costs to borrow from fed)
• sell bonds
• this decrease MS, C, I, AD
• increases r

Question 10

What is the theory of liquidity preference

Answer 10

money demand, how much wealth people want to hold in liquid form.

Question 11

what are the three reasons people hold money

Answer 11

• transaction demand: buying g and s
• precautionary demand: to make unexpected purchases
• asset demand: serve as a temporary store of value

Question 12

How do changes in money supply affect interest rate

Answer 12

increase in MS = decrease in r
- when there is an increase in money supply there is money more easily available to be loaned out so more people can have loans so you can make the loans/assets more easily accessible by lowering the interest rates which makes the cost of borrowing lower

decrease in MS = increase in r
- When there is less money readily available to be loaned out not as money people can get loans so they have to make it harder to get a loan/asset by increasing the rates so less and less people are able to afford borrowing

Question 13

How do changes in money demand affect interest rate

Answer 13

• directly related, increase in money demand = increase in interest rate
• when money demand is increasing the fed must increase interest rates to entice them not to hold as much money and invest instead
• when money demand is decreases the fed decreases interest rate to entice people to hold more money of their own

Question 14

who is in charge of fiscal policy

Answer 14

president and congress with budgetary process

Question 15

what are the 3 tool of fiscal policy

Answer 15

• changes in G
• changes in T
• Changes in Transfer payments (unemployment, stimulus)

Question 16

What is the direct expenditure effect

Answer 16

• If G changes AD changes by = amt
• if T or TP cage AD changes by less than the T or TP change (people save extra income)

Question 17

Spending multiplier effect

Answer 17

increase in spending will lead to increase in RGDP that are larger than the initial change in spending. (there will always be additional increases in income and consumption)

Question 18

How does the multiplier affect the size of a change in spending

Answer 18

As R increases, Money multiplier decreases and MS decreases (meaning spending has decreased)

Question 19

how does crowding out affect the size of a change in spending

Answer 19

an increase in government spending leads to a decrease in private spending as it costs more to invest and consume as the G has driven up the prices. The initial increase in government spending that should have a multiplier affect and help economy is then offset by a small amt from the coding out.

Question 20

what is the effect of a change in spending vs a change in taxes

Answer 20

A Change in government spending can increase revenue, income, wages, disposable income. A change in taxes gives people more disposable income.

Question 21

what is the spending multiplier

Answer 21

tells you the total change in GDP that will occur based on the change in Aggregate spending

Question 22

what is the tax multiplier

Answer 22

tells you the total change in GDP that will occur as a result of the change in taxes

Question 23

Pro stabilization policy

Answer 23

• helps smooth out fluctuations in economy
• helps to maintain unemployment and inflation
• helps to fix peoples confidence in the economy

Question 24

Against stabilization policy

Answer 24

• recognition lag: takes time to recognize problem
• action lag: takes time to implement, fiscal long due to checks and balances
• affect lag: takes Time for it to affect economy. long for monetary as it chaining interest rates is not direct. takes time for biz to change choices on borrowing and spending

Question 25

what are automatic stabilizers

Answer 25

changes in policy that affect AD wihtout policy makers having to act as they are already built into the system, they are shock absorbers that automatically reduce short run fluctuations