Economics: Macroeconomic Analysis Flashcards

Question

Aggregate Output: Short-Run Disequilibrium

Answer 1

* A supply shock decreases SRAS * Prices rise to P₁ and output declines to GDP₁ * Government can address inflation or recession, not both * It can take a long, difficult time for wages and input prices to fall

Answer 2

**_Same as factors that increase LRAS_** 1. Increase in labor supply 2. Increased availabilit of natural resources 3. Increased stock of physical capital 4. Increased human capital (labor quality) 5. Advances in technology/labor productivity

Answer 3

**Potential GDP =** Aggregate hours worked x labor productivity **_Growth_** **in Potential GDP =** growth in labor force + growth in labor productivity **Long-term equity returns are dependent on sustainable growth**

Answer 4

**Y = A x *f*(L, K)** ## Footnote where: Y = aggregate economic output L = size of labor force K = amount of capital available A = **total factor productivity**, the increase in output not from increases in labor and capital, closely related to advances in technology

Answer 5

One measure of eocnomic progress is **output per worker** Because of the diminishing marginal productivity of capital, progress in developed countries relies on technology.

Answer 6

**Growth in potential GDP =** **growth in total factor productivity +** **W_C (growth in capital) +** **W_L (growth in labor)** Where the weights are each factor's share of national income

Answer 7

**Growth in per-capital potential GDP =** **growth in technology +** **W_C(growth in _capital-to-labor ratio_)** In developed countries, K/L is high and growth in per capital GDP must come from technolical advancement

Answer 8

* Eariy in a **contraction**, sales slow unexpectedly, casusing unplanned increase in inventories to above-normal levels * Early in an **expansion**, sales increase unexpectedly, causing unplanned decrease in inventories; inventory/sales ratios decrease to below-normal levels

Answer 9

* Firms are slow to hire/lay off employess or increase/decrease physical capital because frequent adustments are costly * At the beginning of a contraction, sales fall and both l**abor and capital are used less intensively** * At the beginning of an expansion, sales increase and both **labor and captital are used more intensively** * When sales trends persist, firms adust labor and physical capital over time

Answer 10

* _Highly cyclical_ sector of the economy * Activity determined by: * **Mortgage Rates:** Rates Increase, as housing decreases * **Income / housing costs:** When income rises, housing rises * **Speculation:** Home purchases based on expected price increase * **Demographics:** Household formations, geographic shifts in population density.

Answer 11

* **Imports** determined by domestic incomes - depend on domestic business cycle * **Exports** determed by foreign incomes- independent of domestic business cycle * Both imports and exports influenced by **currency exchange rates** * Domestic currency appreaciates: Imports Rise, Exports Fall * Domestic currency depreciates: Imports Fall, Exports Rise

Answer 12

* **Frictional** unemployment results from time it takes employers and employees to find each other * **Structural** emloyment results from long-term changes in the economy that require workers to gain new skills to fill new jobs * **Cyclical** unemployment results from changes in economic growth; = 0 at full employment.

Answer 13

To be counted as unemployed, a person ust be available for work and actively looking for work Labor force consists of those who are employed and those who are unemployed

Answer 14

* Discouraged Workers and Participation Ratio * **Discouraged workers** are those who are avaiable for work but not emplyed or seeking employment; considered not in labor force and not counted as unemolued.

Answer 15

* **Inflation:** Persistent increase in price level over time * **Inflation rate:** Percent increase in price level over a period (usually one year) * **Disinflation:** Decreae in positive inflation rate over time * **Deflation:** Persistent decrease in price level over time; negative inflation rate * **Hyperinflation:** Out-of-control high inflation

Answer 16

* A **price index** is a weighted average of goods and services prices compared to a base period used as a proxy for the overall or average price level * The **consumer price index** (CPI) measures the cost of a fixed "basket" of goods and services compared to the cost in a base period

Answer 17

* Find the cost of the CPI basket in the base period * Find the cost of the CPI basket in the current period

Answer 18

* **Price index for personal consumption expenditures:** Surveys businesses instead of consumers * **GDP Deflator** * **Producer price index**: Crude materials, intermediate goods, finished goods price

Answer 19

* Price indexes that include all goods and services measure **headline inflation** * **Core inflation** refers to prices of all goods excluding food and energy * Food and energy prices are subject to large short-term fluctuations that can magnify or mask the true inflation rate.

Answer 20

* The CPI is widely believed to **overstate** the true rate of inflation * The most significant biases in the CPI data includeL * Consumer **substitution** of lower-priced products for higher-priced products * **New goods** replace older, lower-priced products * Price increases due to **quality improvments.**

Answer 21

CPI is calculated using basket weights from base period (**laspeyres index**) A **Paasche index** uses basket eweights from current period and compares cost to base period **Chained price index** reduces bias from substitution (e.g. Fisher index = geometric mean of Laspeyres and Paasche indexes)

Answer 22

* **Cost-push (or wage-push) inflation**: increases in wages or other producer input prices decrease short-run aggregate supply, increase price level * **Demand-pull inflation:** Increase in aggregate demand above full employent increases price level

Answer 23

* **NAIRU** is the lowest unemployment rate that will not induce wage-push inflation; also called natural rate of unemployment * Likely varies over time and across countries * Not necessarily the same as "full employment" or cyclical unemployment = 0 because wage pressure may be in economic segments

Answer 24

Turning points in these tend to precede business cycle peaks and troughs

Answer 25

* Turning points in these tend to coincide with business cycle peaks and troughs

Answer 26

* Turning points in these tend to follow business cycle peaks and troughs * Unemployment rate is a lagging indicator

Answer 27

* **Management of the supply of money and credit** * **Expasionary:** increase the money supply, decrease interest rates, increase aggregate demand * **Contractionary:** Decrease the money supply, increase interest rates, slow economic growth and inflation

Answer 28

* **Government decisions on taxing and spending** * **Expansionary:** Increase spending and/or decrease taxes; increase the budget deficit, increase aggregate demand * **Contractionary:** Decrease spending and/or increase taxes; decrease the budget deficit, reduce aggregate demand

Answer 29

* Medium of exchange * Unit of account * Store of value Much more efficient than barter economy

Answer 30

**Narrow Money (M1 in U.S. and Eurozone)** * Currency in circulation * Checkable deposits * Travelers checks **Broad Money (M2 in U.S. and M3 in Eurozone)** * Savings deposits * Time deposits \< $100,000 * Money market mutual funds

Answer 31

In a **fractional reserve banking** system, a bank is required to hold a fraction of its deposits in reserve; this fraction is the **required reserve ratio** **Example:** Bank 1 receives $1,000 in new reserves- can loan out $800 in RR of 20% $800 in loans deposited, $640 in new loands... $640 deposited, 0.8 x 640 = $512 new loands... * **Potential** increase in the money supply is * 1/.2 or 5 x $1,000 = $5,000 * **Maximum deposit expanision multiplier = 5**

Answer 32

**Transactions demand:** Increases with GDP **Precautionary demand:** Money held for unforeseen future needs, increases with GDP **Speculative demand:** Money held to take advantage of future investment opportunities, smaller when current returns are high, greater when risk is perceived to be high **_Supply of money_** is set by the monetary authority, central bank

Answer 33

**Riskless nominal interest rate = real interest rate + expected inflation** There is also uncertainty about future inflation rates and other economic variables, and a risk premium that increases with uncertainty **Riskless nominal interest rate = real riskless rate + expected inflation + risk premium for uncertainty**

Answer 34

* Issue currency * Banker to bansk and governmet * Regulate banking and payment systems * Lender of last resort * Hold gold and foreign currency reserves * Conduct monetary policy

Answer 35

All central banks have price stability (low inflation rates) as an obective. Many (except U.S. and Japan) have explicit target rates, usually **2% to 3%** _Some central banks also attempt to:_ * Maintain full employment * Promote economic growth * Keep exchange rates stable * Keep long-term interest rates moderate

Answer 36

* **Expected inflation** increases cost of holding money, adds cost of frequently changing advertised prices * Additional costs of **unexpected inflation:** * Shifts wealth from lenders to borrowers * Less reliable _supply/demand information_ in price changes * Incorrect production decisions by firms * Less stable business cycle

Answer 37

**_Policy rate:_** Interest rate central banks charge for borrowed reserves * By raising the policy rate, Fed discourages banks from borrowing reserves; thus, they reduce their lending * Decreasing the discount rate tends to increase the amount of lending and the money supply * The U.S. Fed sets a target for the fed funds rate, the rate at which banks lend short-term to each other

Answer 38

**_Open market operations:_** *Most often used* * Central bank buys government securities for cash, reserves increase, money supply increases * Selling securities decreases money supply **_Required reserve ratio:_** *Seldom changed* * Reducing required reserve percentage increases excess reserves and increases the money supply * Increasing required reserve ratio decreases the money supply

Answer 39

To be effective, central banks should be: * **Independent-** free from political interference * _Operation independence_: Free to set policy rate * _Target independence (ECB):_ Sets inflation target, measures inflations, determines horizon to meet target * Not absolute; viewed as degree of independence. * **Credible:** Banks follow through on states intentions and policies * **Transparent:** Bank discloses inflation reports, indicators they use, and how often they use them A central bank that is independent, credible, and transparent can influence expectationsl policy changes are anticiplated and easier to implement.

Answer 40

**_When a central bank buys securities:_** * Bank reserves increase * Interbank lending rates decrease * Short-term and long-term lending rates decrease * Businesses increase investment * Concumers increase house, auto, and durable goods purchases * Domestic currency depreciates, exports increase Overall, aggregate demand increases, increasing real GDP, employment, and inflation

Answer 41

**_Expansionary monetary policy affects four things:_** 1. Market interest rates fall, less incentive to save 2. Asset price increase, wealth effect, consumption spending increases 3. Expectations for economic growth increase, may expect further decreases in interest rates 4. Domestic currency depreciates, import prices increase, export prices decrease Overall, aggregate demand increases, increasing real GDP, employment, and inflation

Answer 42

* **Interest rate targeting:** Increase money supply growth when interest rates are above targets, decrease money supply growth when interest rates are below target * **Inflation targeting:** Target band for inflation rate (typically 1% to 3%) * Increase money suppy growth when inflation is below target band, decrease money supply growth when inflation is above target band * Target inflatinn band \>0 to prevent deflation

Answer 43

* **Exchange rate targeting:** Target band for currency exchange rate with developed country * Sell domestic currency when above target * Buy domestic currency when below target (limited by available foreign reserves) * Central bank does not react to domestic economic conditions * Result of successful exchange rate targeting is _same inflation rate_ in domestic economy as in targeted developed country.

Answer 44

Neutral interest rate = trend growth rate of real GDP + target inflation rate **Policy rate \> neutral rate:** **_Contractionary_** **Policy rate \< neutral rate:** **_Expansionary_**

Answer 45

1. Long-term rate may move oppositely to short term rates because inflation expectations change 2. If monetary tightening is etreme, expectations of recession may make long-term bonds more attractive, decreasing long-term rates 3. If demand for money is very elastic, people will hold currency even as money supply increases, referred to as a **liquidity trap** 4. Banks may desire to increase capital and not increase lending in response to expansionary monetary policy 5. Short-term rates cannot be below zero--limits a central bank's ability to act against deflation Recently, central banks have employed **quantitative easing** (QE), buying longer-dated government securities, mortgage securities, and risky bonds

Answer 46

**Expansionary Fiscal Policy** Increase government spending, decrease taxes, or both--increasing aggregate demand and the budget deficit **Contractionary Fiscal Policy** Decrease government spending, increase taxes, or both--decreasing aggregate demand and budget deficit

Answer 47

* **_Keynesian economists_** believe discretionary fiscal policy can stabilize the economy, increasing aggregate demand to combat recession and decreasing aggregate demand to combat inflation * **_Monetarists_** believe that such effects are temporay and that appropriate monetary policy dampen economic cycle * **_Automatic stabilizers_** (taxes and transfer payment) tend to increase deficitis during recessions and decrease deficits during expansions

Answer 48

**Governments use fiscal policy to:** 1. Influence aggregate demand and economic growth 2. Redistribute wealth 3. Affect the allocation of resources to different sectors of the economy

Answer 49

1. **Transfer payments:** Cash payments by government to redistribute wealth 2. **Current spending:** Purchases of goods and services 3. **Capital spending:** To increase future productivity; on infrastructure, or to support research on and development of new technologies

Answer 50

_**Direct taxes-**-levied on income or wealth_ Takes time to implement _**Indirect taxes**--levied on goods and services_ Quick to implement to raise revenue or promote social goals (e.g. tobacco tax)

Answer 51

Note: MPC is Marginal Capacity to consume and is calculated by change in consumption divided by change in income or ^C/^I

Answer 52

* With MPC = .8, a tax increase of $100 billion will reduce consumption by .8 x 100 = $80 billion * The fiscal multiplier effect will, over time, lead to a decrease in consumption spending of 2.27 x $80 billion = $182 billion The **balanced budget multiplier** is positive A $100B increase in spending + a $100 billion increase in taxes ca, over time, increase consumption spending by $227 - $182 = $45B

Answer 53

* If a tax decrease causes taxpayers to increase savings in anticipation of higher future taxes, the resulting descrease in spending will reduce the expansionary impact of a tax cut * If the increase in saving (decrease in consumption) just offsets the tax decrease, it is termed **Ricardian equivalence** * An increase in spending funded by issuing debt will have no impact on aggregate demand

Answer 54

If the real interest rate on government dbt is less (greater) than the real rate of growth, debt ratio will decrease (increase) over time

Answer 55

Reasons to be concerned about deficits * Higher future taxes will decrease GDP growth * Government borrowing can drive up interest rates and reduce (crowd out) private investment * At some point, debt can become risky, interest rate rises, country may default or expand money supply and cause inflation

Answer 56

Arguments that deficits are **not** concerning * If the deficit is to finance capital investment, future GDP will be higher * Deficits don't matter if Ricardian equivalence holds * If the economy is operating below capacity, government borrowing will not displace capital investment

Answer 57

* Recognition lag: To identify the need for fiscal policy change * Action lag: To enact legislation * Impact lag: For the policy change to have the intended effect **Lags can cause fiscal policy changes to be destabilizing rather than stabilizing**

Answer 58

* If the economy is at full employment, fiscal stimulus will result in higher inflation * If the economy is below full employment, due to supply shortages, fiscal stimulus will lead to inflation rather than GDP growth * If the economy has high unemployment and high inflation (stagflation), fiscal policy cannot address both

Answer 59

* Whether fiscal policy is expansionary or contractionary depends on the business cycle stage * An adjusted, or full-employment, deficit amount can be used to adjust for the business cycle stage _In general:_ Spending increases, tax decreases -- **expansionary** Spending decreases, tax increases -- **contractionary**

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Economics: Macroeconomic Analysis Flashcards

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