Exam 3 Flashcards
Financial shocks
any change in borrowing conditions that affect the real interest rate (shifts MP curve)
Spending shocks
any change in aggregate expenditure at a given real interest rate and income (shifts IS curve)
Supply shocks
any change in production costs that leads suppliers to change the prices they charge at any given level of output (shifts the Phillips curve)
Monetary policy
when the fed reserve raises or lowers the risk-free real interest rate (shifts MP curve)
Financial market risks
any change that makes banks more reluctant to lend money at a given interest rate will raise the risk premium and shift MP curve up
Three causes of inflation
Expected, Demand pull (movement along the curve), cost push inflation (shift the curve)
What does the Phillips curve show
relationship between output gap and unexpected inflation
What causes cost push inflation
input price change, productivity, and exchange rate changes
what is the multiplier
the amount of GDP change as a result of an extra dollar of spending
What affects the multiplier
MPC and MPS
MPS
the proportion you spend when you receive an extra dollar
MPS=
1-MPC
Multiplier equation
1/1-MPC
Social insurance
refers to gov provided insurance against bad outcomes
WHat do states provide
health care, human services, and education
Mandatory spending
terms of spending written into legislation
Discretionary spending
spending that congress annually appropriates
What do payroll taxes fund
social insurance (applies only to earned income)
earned income
wages, net earnings from self-employment, bonuses, commission
progressive tax
more you earn the higher your taxes
Automaatic stabilizers
spending and tax programs that adjust as the economy expands and contracts without policymakers taking action
Income tax
tax on taxable income
corporate tax
taxes on business owners
Where does fed gov revenue come from
income, payroll, and corporate tax
Sales tax
tax you pay on purchases, on total purchases (state and local)
Excise tax
tax on specific products based on quantity (alcohol, gas)
Property tax
% of value of property
Regressive taxes
the higher the income the less fraction you pay in tax
Marginal tax rate
the tax rate you pay if you earn an additional dollar
Tax expenditures
special deductions, exemptions, or credits that lower your tax obligations to encourage you to engage in certain activities
Examples of tax expenditures
American opportunity tax credit
Earned income tax
Who do tax expenditures benefit and why?
The higher income group because they spend more on tax-preferred goods and services
Fiscal policy
choices in spending and taxes to help stabilize the economy
Expansionary fiscal policy
gov expanding the economy: more spending, lower taxes
Contractionary fiscal policy
If the economy is overheating: less spending, higher taxes
What is considered good fiscal policy?
Timely, targeted, temporary
When was the Fed reserve created
by congress in 1913
What does the fed reserve consist of?
board of governors and 12 federal reserve district banks
What does the fed reserve do?
issues national currency and checks where your money comes from
Important characteristics of the fed
- regionally diverse
independence with check and balances– monetary policy is not influenced by political pressure
FOMC or Federal Open Market Committee
The board of governors and the presidents of the fed districts meet to determine monetary policy
WHat is discussed at an FOMC meeting?
- What is the forecast for the U.S. economy
- What are the right policy choices given the economic output
- How should the Fed Communicate its plan to the public
What are the two policy goals of the Fed?
Price stability and Maximum sustainable employment
WHy does the Fed focus on targeting inflation more than employment?
- More straightforward to influence inflation with interest rate
- Inflation and unemployment interconnect
Why not 0% inflation target?
- Inflation greases the wheels of the labor market– allows firms not to cut wages
- The fed can lower real interest rate by more
- A 0% inflation rate runs the risk of deflation
- Measured inflation might be overstated
How does the fed choose interest rate
- Start with neutral real interest rate
- Targets nominal interest rate to influence real interest rate
- Compares inflation with target inflation
- Looks at output gap
Neutral real interest rate
real interest rate at which GDP is equal to potential GDP
Forward guidance
providing information about the future course of monetary policy in order to influence market expectations of future interest rate
Quantitative easing
purchasing large quantities of longer-term government bonds and other securities in an effort to lower long-term interest rates
Lorenz curve
summarizes income distribution in graph form
Gini coefficient
a single statistic that summarizes the degree of inequality described by the Lorenz curve
Gini equation
Gini=A/(A+B)
Gini coefficient perfectly equal
equal to zero (B takes over everything)
Gini coefficient perfect inequality
A/A=1 the higher the gini the more inequality
Intergeneration mobility
the extent to which economic status of children is independent of the economic status of their parents
poverty rate
family income below the poverty line
absolute poverty
judges the adequacy of resources relative to an absolute standard of living
Relative poverty
judges poverty relative to the material living standard of your contemporary society
means-tested
the eligibility of social safety nets determined by income-level
Cost of redistribution
administrative cost
reduced incentive to work
bad actors (tax evasion and tax avoidance)
Production possibility frontier
a way of modeling a resource constraint
What causes a PPF to be bowed out
resources are not equally productive
diminishing return to production
Utility function
measure of happiness with consumption
Indifference curves
a curve where every bundle, you are indifferent to
Rules of indifference curves
- must slope downwards– must give up one good to obtain another
- bowed in because of diminishing marginal utility
- cannot cross because it violates non-satiation (having more of both goods is always better)
Net government debt
debt the government owes to individuals businesses and other governments
Importance of debt
- able to invest in future projects
- boost the economy when the economy is in a recession
Main argument for budget balance
fiscal responsibility
debt ceiling
a limit on how much total US debt the US gov could have
Unfunded liabilities
a commitment to incur expenses in the future without a plan to pay for those expenses
Why worry about debt
- slower economic growth due to crowding out
- limited future fiscal choice
- risk of crisis of confidence
- a debt crisis becomes more likely
Why not to worry about debt
- most owed by americans to Americans
- future generations can help pay the debt
- wont take a big adjustment to repay the debt
- as long as the gov has the capacity to make payments it ok
- gov has options for repayment
