Discussion Sheets Flashcards
Money
Assets that people accept in exchange for goods, services, and debt payments
Functions of money
- Medium of exchange
- Unit of account
- Store of value
- Standard of deferred payment
Commodity money
A good used as money that has some intrinsic value independent of its use as money
ex. gold
Measurement of money (____________)
the money supply
M1
The narrowest (most liquid) definition of money
- currency in circulation (not held by banks of government)
- checking account deposits (demand deposits)
- holdings of traveler’s checks
M2
- M1
- savings account balances
- small denomination time deposits
- balances in money market deposit accounts in banks
- non institutional money market fund shares
Bank Balance Sheets: Assets
Reserves
Loans
Securities
Buildings and Equipment
Other Assets
Bank balance sheets: Liabilities
Deposits
Short-term Borrowing
Long-term Debt
Other Liabilities
Reserves
Deposits that a bank keeps as cash in its vault of on deposit with the Federal Reserve
Required Reserves
Reserves that a bank is legally required to hold, based on its checking account deposits
Required reserves ratio (RR)
The minimum fraction of deposits banks are required by law to keep as reserves
Excess reserves
Reserves that banks hold above the legal requirement
Simple deposits multiplier:
The ratio of the amount of deposits created by banks to the amount of new reserves
Deposit Multiplier = 1/RR
RR = Required reserves ratio
Change in checking account deposits formula
Change in checking account deposits = Change in bank reserves x 1/RR
Monetary Policy
Actions taken by the Fed to manage the money supply and interest rates in order to pursue its macroeconomic policy goals
Goals of Monetary Policy
Price Stability
High Employment
Economic Growth
Stability of Financial Markets and Institutions
Interest rate goes up
effect on consumption
Save more —- consumption down
Interest rate goes up
Effect on investment?
Investment goes down
Interst rate goes up
Effect on investing in U.S ?
Investing in U.S. is more profitable
Interest rate goes up
Effect of the demand of U.S. dollars?
Demand of U.S. dollars goes up
Interest rate goes up
Effect of value of U.S. dollars?
Value of dollars goes up
Interest rate goes up
Effect on X and IM and NX
X goes down
Imports go up
Net exports go down
Interest rate goes up
Effect on Aggregate Expenditure
AE goes down
Interest rate goes down
Effect on AE
AE goes up
Monetary Policy Targets:
Money supply and the interest rate
Money Demand (MD)
A downward sloping curve relating quantity of M1 demanded and the interest rate
Why does the MD curve slope downards?
Tradeoff between liquidity and interest
Recall: the interest rate represents the opportunity cost of holding money
Real GDP: GDP goes up
trade of goods and services goes up=> MD goes up
Shifts Money demand
Price level: CPI goes up =>
more $ needed to buy goods => MD goes up
Shifts Money Demand
Money Supply (MS)
A vertical line illustrating quantity of M1 supplied
Why is the MS curve a vertical line?
The Fed is able to completely control the money supply (via the RR, Open Market Operations, and the Discount Rate), which implies a constant supply of M1 regardless of the interest rate
Equilibrium Money Market
Equilibrium: MS = MD
What are models of the interst rate?
Loanable Funds Market vs. Money Market
The loanable funds model deals with _________________________
the long-term real interest rate (r)
The money market model is concerned with ____________________________
the short-term nominal interest rate (i)
Federal funds rate
The interest rate banks charge each other for short-term (overnight) loans
Monetary Policy and Aggregate Demand:
changes in i affect components of AD
Consumption: interest rate goes down =>
more spending on durables (cars, furniture) and less saving => Consumption up
Investment: interest rate goes down =>
Investment goes up
Net exports: interest rate goes down in U.S. relative relative to other countries =>
investing in U.S. assets less desirable => drop in demand for dollars => value of dollar down => exports from the U.S up / imports from other countries down => NX up
Expansionary Monetary Policy
Fed increases MS to increase real GDP
Contractionary Monetary Policy
Fed decreases MS to decrease inflation
Monetary Policy and Real GDP / Price Level (static AD-AS model)
Expansionary Monetary Policy: Fed increases MS to increase real GDP
Contractionary Monetary Policy: Fed decreases MS to decrease inflation
Monetary Policy and Real GDP/Price Level (dynamic AD - AS model)
Using expansionary policy to get the economy to full employment
Using contractionary policy to prevent high levels of inflation
Taylor Rule
How the Fed chooses a target for the federal funds rate
Federal funds target rate formula
Current Inflation rate + Real equilibrium federal funds rate + (0.5 x Inflation gap) + (0.5 x Output gap)
Real equilibrium federal funds rate
Adjusted for inflation federal funds rate, which is consistent with real GDP being equal to potential real GDP
Inflation gap
Difference between current inflation and a target inflation rate
Output gap
Percentage difference between real GDP and potential real GDP
Money Demand slopes downwards due to ____________
opportunity costs of holding money
Holding all other variables constant, expansionary monetary policy raises _____________
the price level
What kind of line is MS
vertical
An open market operation that increases the money supply increases ____________________________
the holdings of government bonds held by the Federal Reserve
A contraction of the money supply tends to _______________
increase the interest rate, but decrease aggregate expenditures
If policy makers wanted to use monetary policy to stimulate demand and reduce a high rate of unemployment, what would be appropriate?
The purchase of securities in the open market
If the Fed anticipates the economy to be above potential output, it should ___________________
sell U.S. treasury bonds on the open market
Suppose that potential real GDP grows from 14.9 to 15.3 from 2009 to 2010, while real GDP grows from 14.9 to 15.2 during the same time span. What is the likely action of the Fed (what policy)?
Expansionary monetary policy
What will lead to a decrease in the equilibrium interest rate in the economy?
A decrease in GDP
The Fed can increase the federal funds rate by __________________________
Selling Treasury billls, which decreases bank reserves
An increase in the interest rate should _________ the demand for dollars and the value of the dollar, and next exports should ____________
increase
decrease
The money demand curve is downward-sloping because __________________________________
the opportunity cost of holding money rises as the interest rate increases
All of the following factors will shift the money demand curve, except:
Changes in the institutions
changes in real GDP
Changes in the aggregate price level
chages in the interest rate
Changes in the Interest Rate
The federal funds rate is the interest rate on _________________, and is controlled by the _____________
reserves that banks lend to each other
Federal Open Market Committee
Sequence of events in the conduct of contractionary monetary policy using open market operations
The Fed sells bonds, which decreases the supply of federal funds, which raises the interest rate, which leads to a decrease in intended investment spending, aggregate demand and output
The major shortcoming of a barter economy is…..
Requirement of double coincidence of wants
Ted has an orange and wants a peach
Alice has a peach and wants an orange
What does this show?
Double coincidence of wants
In an economy with barter, there are __________ prices than in an economy with money
more
Demand deposits
Currency
Money market mutal funds
List them from most liquid to least liquid
Currency, demand deposits, money market mutual funds
What is something included in M2 but not in M1
Money market mutual funds
Wealth =
currency + checking + saving + Total Assets - debt
If I withdraw $5000 from my savings account and put it in my checking account, M1 will ________ and M2 will ____________
Increase
Not change
If a person withdraws $500 from their checking account and holds it in currency, M1 will _______ and M2 will ______
Not change
Not change
A bank will consider a car loan to a customer as a _____________ and a customer’s checking account as a ___________________
Asset
Liability
Imagine that John deposits $10,000 of currency into his checking account deposit at Bank A and that the required reserve ratio is 20%. Bank A’s reserves immediately increase by ______________. Required Reserves increase by _________
10,000
2,000
Short-run Phillips Curve
A downward sloping curve, which represents the short-run trade-off between unemployment and inflation
Long-run Phillips Curve
Vertical. Means that inflation has no effect on the unemployment rate. The LR Phillips Curve is set permanently with the natural rate of unemployment which corresponds with potential GDP
Shape of the Phillips Curve depends on what?
Expected Inflation
If the price level is lower than expected, real wages ____________________________
are higher than expected, and firms will hire less people than they would have otherwise. Then, we have higher unemployment in the short-run (hence the downward-sloping SR curve)
Why the vertical long-run phillips curve?
We are able to adjust completely for inflation in the long run
Phillips Curve and AD-AS
Interaction
Higher levels of AD imply higher levels of GDP
As GDP rises, unemployment falls, and inflation rises
The Phillips Curve corresponds to shifts in the AD curve
When the SR Phillips Curve intersects LR phillips curve
Inflation = expected inflation
Expected Inflation Formula
(Change in Price / Price level) raised to expected level
Real wage =
(Nominal wage / Price Level) x 100
If inflation is greater than expected inflation
actual real wage is lower than expected => firms higher more workers => Unemployment Rate decreases
There is a different SR Phillips Curve for every __________________
expected inflation rate
An increase in inflation decreases unemployment only if ________________________
the increase in inflation is unexpected
If workers and firms form _______________ using all available information, including the effect of Fed policy, the SR Phillips curve would be vertical, which implies that even in the SR, inflation will be completely expected and inflation has ___________________________
rational expectation
no effect on the unemployment rate
Low inflation (below 4 percent)
firms and workers generally ignore it
Moderate but stable inflation (4-5 percent)
Unable to ignore it; generally use adaptive expectations
i.e. assume inflation will follow the same pattern it has in the recent past
High Inflation (above 5 percent)
Workers and firms are unable to ignore inflation, but are also unable to adjust appropriately and thus real wages/profits fall; use rational expectations
What will happen to real wages if actual inflation is less than expected inflation?
Real wages will rise
Stagflation occurs when the ________________________
the price level increases and real GDP decreases
The Phillips curve shows the relationship between the __________________
unemployment rate and the inflation rat
Suppose that the economy is at full employment an daggregate demand increases by more than it is anticipated to increase. Other things remaining the same, _______________________
real GDP increases above potential GDP
What is held constant when moving along a short-run Phillip’s curve?
The expected inflation rate
An increase in th expected inflation rate leads to ____________ the short-run Phillips curve
an upward shift of
If workers and firms have rational expectations, then the expansionary monetary policy would:
not change unemployment rate
If firms and workers have adaptive expectations, what impact will contractionary monetary policy have on inflation, unemployment, and Phillips curve?
Firms and workers will overestimate the inflation
Unemployment rate will eventually come back to the natural rate and Phillips curve will shift downward
Balance of Payments (BOP)
An accounting of a country’s international transactions for a particular time period
Current account
deals with international trade in goods and services and with earnings on investments
includes:
- trade in goods (trade balance)
- trade in services
- factor incomes (interest payments, dividends, wages)
- Unilateral transfers (gifts, foreign aid)
Financial (capital) account
records transfers of assets
Transactions in this account create liabilities
Account balance =
cash inflows - cash outflows
Current account balance =
- Financial account balance = - Net capital inflows
If net factor income and transfers are zero:
CA = NX = -NCI
Exchange rate is a price on:
the market for foreign exchange
The Real Exchange Rate
The value of one country’s currency in terms of another country’s currency corrected for changes in the price of goods and services
Real exchange rate =
Nominal exchage rate x (Domestic price level / Foreign price level)
If it takes more of the other currency to buy the same amount of dollars
The U.S. dollar appreciates against another currency
Floating currency
A currency that uses a floating exchage rate is known as a floating currency. A type of exchange rate regime wherein a currency’s value is allowed to fluctuate according to the foreign exchange market
Fixed exchange rate
A system under which countries agree to keep the exchange rate among their currencies fixed
ex. gold standard, bretton woods system
To keep exchange rate above equilibium, the united states can:
buy dollars and sell foreign currency
To keep exchange rate below equilibrium, the United States can
sell dollars and buy foreign currency
Mix of two exchange rate regimes
target zone
managed exchange rate
Net capital inflows refers to the purchase of:
domestic assets by foreign residents minus the purchase of foreign assets by domestic residents
An increase in the U.S. real interest rate induces:
foreigners to buy more U.S. assets, which increases U.S. capital inflow
The real exchange rate of British punds to U.S. dollars will increase if the U.K. price level ______ and the nominal exchange rate of pounds to the dollar _________
decreases; rises
A budget deficit raises interst rates, which raises ________
exchange rates
If the Fed is using policy to combat inflation, what will happen in the foreign exchange market?
The demand cor dollar will increase
The foreign exchange value of the dollar will rise
A country that imports a significant proportion of its consumer goods can avoid inflation by adopting a fixed exchange rate because it can avoid the price increases of _______ that occur when the value of the domestic currency __________
imports
falls
