Exam 4 Flashcards
Real GDP is growing at
2.1%
Unemployment Rate
Is at 4.5% (down from 4.7%)
Demand for money is
the demand to hold money as money instead of holding it in some other form of wealth
In the money market, the supply for money is…
is perfectly vertical at any point in time
Shifters for demand for money
- Change in Real GDP
- Real GDP increase; money demand shift right
- Real GDP decrease; money demand shift left - Change in price level
- Price level increase; money demand shift right
- Price level decrease; money demand shift left
How interest rates affect AD
- Consumption
- Interest decrease; consumption increase - Investment
- Interest rate decrease; investment increase - Net Exports
- Interest rate increase; NX decrease
Expansionary
$ increases; interest rates decrease; AD shift right
Contractionary
$ decreases; interest rates increase; AD shift left
Taylor rule purpose
coming up with a target for the Fed rate
Taylor rule formula
Nominal = inflation + real + (weight)(inflation gap) + (weight)(output gap)
How does the Fed measure inflation
Personal Consumption Expenditure Price Index (PCE)
PCE
Personal Consumption Expenditure Price Index (is just the C in GDP)
Core PCE
removes food prices and gas prices (has been used since 2004)
Fed’s Quantitative Easing
- Fed sells a bunch of short-term bonds
- Selling bonds lowers their prices, raising rates
- Uses that $ to buy longer term bonds
- Buying bonds increases their prices, lowering the long-term rates
Bond market size
$37 T
Stock market size
$21 T
Fed’s QE goal
lower the long term interest rate
If price of bonds increase
Interest rate decreases
If price of bonds decrease
interest rate increases
TARP stands for
Troubled asset relief program
TARP info you gots to know
- AKA the bailout
- Singed by Bush in 2008
- Goal was to buy toxic assets from large banks (up to $700 Billion)
MBS
Mortgage backed securities
ABS
asset backed securities
ARRA stands for
American Recovery and Reinvestment Act
ARRA info you gots to know
- AKA the stimulus
- Goal was to get Americans spending again (shift AD right); to pump money into the economy to start the ripple
- Signed by Obama in 2009
- Government spent about $840 billion
- About 63% was G
- About 37% was taxes (which affects C)
Credit Default Swap
like insurance on one of the mortgage backed securities to hedge your risk
If you sold a CDS you were betting
that people wouldn’t default
If you were buying a CDS you were betting
that at least one person would default
The three levels of risk
- Mortgage: people don’t pay mortgage
- The bonds
- The CDS
Crowding out
theory that government spending reduces private spending (C + I)
Three parts of crowding out
- Government spending increases interest rates
- If 1 is correct the C and I are lower than they would be
- AD = C + I + G + (X-M), so G might increase but if C and I decrease, it undoes much of the good…could get a multiplier below 1
(increase G; supply of loanable funds will decrease; Interest Rates increase; C decreases and I decreases
Did crowding out happen?
After we did our government spending, interest rates stayed low until we raised them: so crowding out didn’t happen
Did ARRA (the stimulus) work?
Yes, it made the recession not as bad as it could have been
Tax Multiplier
- (changes in Real GDP) / (changes in taxes)
* (MPC) / (1 - MPC)
Deficit (three important things)
- It is a 1 year thing
- Deficits are normal; we’ve run deficits for 36 of the last 40 years
- Deficits are non-partisan
Debt
add up all of the deficits, year over year over year
- -Debt is normal
- -Debt can be a smart way to grow income
How much is our debt?
$19.8 Trillion
–This is the biggest it has ever been
Debt ceiling
congressional limit on how much debt we can issue
Debt-to-GDP ratio
how much is our debt related to our “income”
- -105%
- **This isn’t the highest we’ve had
Carme Reinhardt and Kenneth Rogoff
Decided that 90% debt-to-GDP ratio was the highest it should be, but were proven wrong by a college student
**There is not magic number to say how much debt is too much
Who do we owe?
- Portion that 1 part of the government owes to another part of the government
- Portion that we owe to citizens (“people like me”)
- Portion we owe to the Fed
- What we owe to other countries
- Portion we owe to State and Local governments
- Portion that 1 part of the government owes to another part of the government
-Trust funds are about $2.8 T
TOTAL: $5.3 trillion
- Portion that we owe to citizens (“people like me”)
about $5.1 T
- Portion we owe to the Fed
about $2.4 T
- What we owe to other countries
about 32%
- $6.4 T
- -China: > $1T
- -Japan: > $1T
- -Ireland: $300 B
- -Cayman Islands: $260 B
- -Brazil: $260 B
- **We owe dollars and we print dollars
- Portion we owe to State and Local governments
about $0.8 T
How much do we owe ourselves total?
$13 T
How to reduce debt?
Must run a surplus
How to reduce debt-to-GDP ratio?
- Gov must reduce deficit
- Increase how much GDP grows
- Lower how much debt grows
Tax Wedge
difference between pre-tax and post-tax return to any activity
Supply side economics says that
cutting taxes on any activity will increase the amount of that activity
a) Cut sales tax; people consume more
b) cut tax on investment; investment increases
c) cut tax on income; increase amount of labor supply
If we lower taxes and nothing else changes…
- Deficit will get bigger
- Debt will get bigger
In what scenario would supply side economics work
- If we have a greater income to tax at a lower rate
- If lower taxes makes people want to work more
- When taxes are extremely high, lowering taxes will increase the incentive to work
Deficit in 2015
$439 B
Deficit in 2016
$587 B
Why was deficit super high around 2009
war and recession
Assume GDP is 8% below where we want it to be, and inflation is 2% above where we want it to be. Also assume the current inflation is 3% and the real Fed Funds Rate is 2%. According to the taylor rule, if the weights on the output and inflation gap are each .5, what should the nominal Fed Funds rate be set at?
a. 1%
b. 2%
c. 3%
d. 4%
b
Which of the following is correct regarding the discussion as to how changes in interest rates affect AD?
a. Lowering interest rates will make the dollar stronger, which makes net exports increase
b. Raising interest rates will make the cost of purchasing a new home higher, which makes C decrease
c. Lowering interest rates will make the cost of purchasing big ticket items (like cars) lower, making consumption increase
d. none of the above
c
As discussed, the money market is primarily concerned with ______ interest rates which the market for loanable funds is primarily concerned with _______ interest rates.
shorter term; longer term
Which of the following is correct regarding TARP?
a. It was created to purchase “toxic” assets from large banks
b. it was an example of fiscal policy designed to shift AD to the right
c. both b and a
d. neither a nor b
a
As discussed, which of the following was the specific ultimate goal of the Fed’s recent quantitative easing?
a. to reduce short term interest rates
b. to reduce the money supply
c. to reduce long term interest rates
d. to reduce inflation
c
What was the term for the type of securities that were a bunch of mortgages bundled together into something like a bond?
a. collateralized debt obligation
b. asset backed security
c. mortgage backed security
d. all of the above
d
The portion of our debt that one part of the government owes to another part of the government (not the Fed) is…
a. approx. $5.2 trillion; 26% of our debt
b. approx. $1.2 trillion; 5% of our debt
c. approx. $12 trillion; 67% of our debt
d. none of the above
a
As discussed, which of the following is most accurate?
a. Because we have run government deficits for many years, interest rates are relatively high
b. despite having run government deficits for many years, interest rates are relatively low
c. because we have run government deficits for many years, interest rates are relatively low
d. despite having run government deficits for many years, our interest rates are relatively high
b
Which of the following is most correct?
a. the need to increase the debt ceiling is a relatively new phenomenon
b. the fact that we have a government budget deficit is a relatively new phenomenon
c. both a and b
d. neither a nor b
d
Our current level of debt is ______ and our current debt to GDP ratio is __________.
$19.8 trillion; 105%
Which of the following is not listed as one of the three impacts of reducing individual income taxes?
a. an increase in the amount of labor supplied
b. an increased willingness to save since the return to saving is higher
c. an increased willingness to open new businesses
d. an increase in the pace of technological change
d
On an AS/AD graph the impact of supply-side income tax cuts was shown as what?
a. a leftward shift of SRAS curve
b. a leftward shift of LRAS curve
c. a rightward shift of both the AD and SRAS curves
d. none of the above
d (a rightward shift of the LRAS curve)
Which of the following was not listed as one of the three impacts of reducing corporate income taxes?
a. the pace of technological change might increase
b. corporations would see a higher return on investment in new equipment
c. corporations would hire more employees if their tax rates fell
d. actually, all three were listed
c
Supply-side economics gained popularity during the term of which U.S. President?
Ronald Reagan
Which of the following is not correct regarding the US marginal tax system?
a. in the US marginal tax system, a person in the “35%” tax bracket pays 35% of their income in taxes
b. in the US marginal tax system, a person in the “35%” tax bracket only pays 35% on the top portion of their income
c. in the US marginal tax system, the highest tax bracket is currently much lower (% wise) than it has been in the past
d. none of the above
a
Consider the ARRA. Which of the following is most accurate? The ARRA was an example of ____ policy and was made up ____.
a. Fiscal; tax cuts but not gov spending
b. Monetary; gov spending but not tax cuts
c. Monetary; tax cuts and gov spending
d. Fiscal; tax cuts and gov spending
d
If the MPC is .6 how much would tax cuts of $400 billion amount to, using the tax multiplier, after they rippled through the economy?
600; (.6 / .4) = 1.5 so 1.5 * 400 = 600
The largest source of revenues flowing into the Federal gov comes from…
a. corp taxes
b. individual income taxes
c. excise and sales taxes
d. conformance and compliance taxes
b
What condition could cause the government multiplier to be < 1?
a. the gov spending would have to increase the overall price level causing C to decrease
b. The gov spending would have to increase tax rates, causing the C to decrease
c. the gov spending would have to increase unemployment causing C to decrease
d. none of the above
d (the government spending would have to increase the interest rate)
Assume actual GDP is $15 t and potential GDP is $19 t. A tax cut of $1 t successfully filled a gap between the two. What is the value of MPC?
.8 (If MPC = .8, tax multiplier is (MPC/(1-MPC)) or (.8/.2) or 4 and 4 * 1 trillion = 4 trillion
If crowding out works how it is supposed to, we would see G ____ but see C and I both _____ and we’d see AD _________.
a. decrease; increase; shift right and then shift left
b. decrease; increase; shift left and then shift right
c. increase; decrease; shift left and then shift right
d. increase; decrease; shift right and then shift left
d
Short-run Phillips Curve Shifters
Expected Inflation increase; shift up
Expected Inflation decrease; shift down
In long-run phillips curve we always end up
back at potential GDP which means unemployment always returns to its natural rate
If actual inflation > expected inflation
unemployment is low
If actual inflation < expected inflation
unemployment is high
Trade-off happens when
expectations are wrong
