Exam #4 Review Flashcards
automatic stabilizers
government spending and taxes that automatically increase or decrease with the business cycle
automatic stabilizers
government spending and taxes that automatically increase or decrease with the business cycle
when times are good, tax revenues ___________,
increase
when times are bad, government spends more on ___________
unemployment
XX% of government revenues come from individual taxes
42%
xx% of government revenues come from corporate taxes
9%
are revenues from corporate taxes increasing or decreasing?
Decreasing. Today, 9% of gov revenue is from corporate taxes. Five years ago, corporate taxes accounted for 14.5% of revenue
XX% of government revenue comes from social security
40%
xx% of governmetn revenue comes from excise taxes, tariffs
9%
xx% of government expenditures goes to transfer payments (social security, unemlpoyment, medicare)
43%
xx% of government expenditures goes to defense
20%
xx% of government expenditures goes to grants to local/state governments
15%
xx% of government expenditures goes to interest on debt
8%
xx% of government expenditures goes to other departments of the government
14%
federal debt
total of all the government’s yearly deficits
deficit
any year the government spends more than it takes in
are deficits normal?
yes, but the size of our deficit isn’t really that normal
in 2012, the federal budget deficit was….
1.1 trillion
a budget deficit in one year may be the result of policy put into place in a previous year (t or f)
true
are the size of the US’ deficits increasing or decreasing from year to year?
they are decreasing, which means the debt is increasing by a smaller and smaller margin each year
what is the current US national debt?
$16.7 trillion
US Saving bonds
when you buy a bond, you loan the government money…this is our debt!
what is the portion of the debt that one part of the federal government owes to another part of the federal government?
$4.8 trillion
what is the portion of the federal debt that the federal government owes people like you and I?
$3.8 trillion
portion of US debt that the federal government owes to other countries
$5.4 trillion
what country does the US owe the most to?
China, $1.16 trillion
portion of the debt the federal government owes the Federal reserve
$1.9 trilion
portion of the federal debt the government owes to local and state governments
$0.7 trillion
how is debt actually a tool?
it enables companies to finanace new projects and expansions
US’ current Debt-to-GDP Ratio
105%
is America’s Debt to GDP ratio alarming?
No, it is higher than usual but other countries are still higher
how do we reduce the debt?
government must actually eliminate the deficit and run a surplus
how likely is it that America will not run a deficit?
not likely, the government has only had 4 surpluses in the past 40 years
how do we reduce the debt-to-GDP ratio?
government must reduce yearly deficit
- GDP must grow at a faster rate than the debt does
- for example, if in 2013 GDP grows at a rate of 5% and debt grows at a rate of 3%, we are reducing the ratio
In the Market for Loanable Funds, what is on the X and Y axises?
Y-axis: interest rate
X-axis: quantity of loanable funds
In the market for loanable funds, what lines slope upward and downward?
Savings supply line curves upward
-investment demand curves downward
When the government runs a deficit both savings and investments ___________
decline
crowding out
when investment declines because the government borrows and spends
is crowding out a problem as of late?
No, interest rates have not seemed to increase
How big of a problem is the debt/deficit? 3 things to know:
interest we pay is money that cant be used for something else
- deficits can raise interest rates, but this isnt happening
- higher interest rates can crowd out private investment…also does not seem to be happening
The American Recovery and Reinvestment Act
- purpose was to shift AD to the right
- $825 billion in the form of government spending and tax reductions
what percent of the ARRA was in the form of government spending?
63%
what percent of the ARRA was in the form of tax adjustments?
37%
at a minimum, what difference in GDP did the ARRA make?
at a minimum, 3%. Maybe even up to 9%
multiplier formula
1 / (1-MPC)
what causes the multiplier to be less than 1?
crowding out can give you a multiplier less than 1
-this is dependent on interest rates going up
tax multiplier formula
changes in REAL GDP / changes in taxes
OR
MPC / (1-MPC)
tax multiplier example:
taxes cut by $100 billion, MPC = .75
.75 / (1-.75) or 4
tax wedge
difference between pre-tax and post-tax return to any activity
-if you’re paid $20 an hour but are taxed at 20%, the tax wedge is $4 per hour
what is the basic argument for supply side economics?
cutting taxes on any activity will increase the level of that activity
cutting taxes on consumption, people will increase _____________ (according to supply side)
consumption
cutting taxes on investments (buying equipment), companies will increase ___________
investment
cutting taxes on income will increase the amount of _____________, which increases output
labor supplied
According to Supply side economics, cutting taxes on individual income will:
- increase the quantity of labor supplied
- increase openings of new businesses
- increase savings
- since savings income would be taxed less
According to supply side economics, cutting corporate income taxes would:
- encourage investment (buying new technology)
2. spur innovation and technological advances
argument against supply side
- just because we can produce more doesn’t mean we will produce more AND certainly doesn’t mean we will demand more
- all of this shifts AD and LRAS right, but leaves SRAS by itself without movement
tying supply side theory to the debt and deficit, what will happen if we lower taxes?
deficit will get larger, debt will get larger
what would supply side economists argue about lowering taxes and increasing the deficit?
- lower taxes, this increases GDP
- GDP is our income
- lower taxes on higher income can theoretically produce higher tax revenue
- you can cut taxes and decrease the deficit, both at the same time time! tax cuts pay for themselves
- —only politicians argue this
does cutting taxes increase the incentive to earn?
it can if the difference in tax rates is significance
-in past decades, data shows that tax brackets are close enough that it is not a significant influence on whether people will work more or less
does an increased incentive to earn lead to higher GDP and higher GDP growth?
- not necessarily and not always
- some economists argue that the increase in the quantity of labor supplied following a tax cut will be limited because many people work a number of hours set by their employers and lack the opportunity to work additional hours
- even more: salaried employees unaffected; increase in the amount of labor supplied does not translate to additional compensation
demand for money
the demand to hold money as money instead of holding it in some other form of wealth like a government bond
demand for money is _______ related to interest rates
inversely
demand for money curve:
x and y axises
X-axis: quantity of money
Y-axis: interest rate
demand for money curve slopes ______,
supply of money curve slopes_______
downward
perfectly vertical
Two things that shift the demand for money curve
- a change in Real GDP
2. a change in the price level
if real GDP goes up, demand for money goes _________
up
if the price level goes up, demand for money goes ________
down
supply of money curve
perfectly vertical line eual to the current supply of money
equilibrium interest rate
intersection of supply of money and demand for money curve
which one sets the interest rates, the loanable funds market or the money market?
market for loanable funds concerned with long term interest rates
-money market concerned with shorter term interest rates
what kind of things used the long term interest rates of the market for loanable funds?
investor buying a corporate bond, business udnertaking investment, consumer buying a house
what kind of things use the short term interest rates of the money market?
fed funds rate
what 3 things of AD do the interest rates affect?
- consumption
- investment
- net exports
the effect of interest rates on AD:
consumption
when rates are lower, people more likely to buy houses, cars, furnitures
-when rates are low, people likely to save less and spend more
the effect of interest rates on AD:
investment
when rates are lower, firms will borrow more to undertake new projects, purchase new equipment
-when borrowing costs are lower, break even point on new projects reached more easily
the effect of interest rates on AD:
net exports
-if interest rates rise in the USA, AD decreases
why does AD increase with rising interest rates in the USA with regards to net exports?
if interest rates rise in the USA, investors from other countries like to buy our bonds
- increase in demand for our bonds increases the demand for US dollars in the foreign exchange market
- an increase in the demand for dollars makees the dollar stronger compared with other currencies
- when the dollar is stronger, we buy more imports because our dollar goes further buying foreign goods
- when we buy more imports, AD goes down
- therefore, when intrest rates go up in the US, AD decreases
Taylor Rule
shows how this conflict affects the Federal Reserve’s target for the fed funds rate
Taylor Rule formula
Fed funds rate = inflation + real + a measure of the difference between actual inflation and desired inflation + a measure of the difference between actual GDP and desired GDP)
Taylor Rule example:
current inflation is 3%, current real rate of interest is 1%, inflation is 2% higher than we want it to be, GDP is 6% is lower than we want it to be
Fed funds rate = 3 + 1 + (.5)(2) + (.5)(-6) = 2
beginning of the financial crisis
to spur economy, Greenspan lowered interest rates
-this made US treasury bonds a less attractive investment but it made borrowing much easier
securitization
big businesses take a bunch of the mortgage loans, bundle them together, make it into something like a bond, and sell it to investors
collateralized debt obligations
a special type of when the clump of mortgages were split into 3 sections: top tranche (safest, least risky), middle tranche (a little risky), bottom tranche (most risky)
credit default swap
insurance on one of these mortgage-backed securities
essentially, what was the credit default swap?
it was a bet! a bet that if you sold one, you were betting that people wouldn’t default on their mortgages and you’d never have to pay out
3 levels of risk with the mortgage system
- initial mortgages themselves, which went bad
- the bonds based on the mortgages, which eventually went bad
- the credit default swaps, the insurance, which eventually had to be paid out
results of this mortgage crisis
thousands of houses/condos bulit to meet this demand
- increased supply of houses floods the market, house prices start to fall
- interest rates had risen
- people start to default on their mortgages
Bernanke and Fed’s role in solving crisis
- Bernanke’s specialty was the Great Depression
- felt they had to do whatever it took to free up the credit markets
- offered to buy toxic assetss off the books of the big banks
TARP (troubled asset relief program)
- allowed the treasury and fed to purchase toxic assets from large banks
- intent: get them to start making loans again…unfreeze the credit market
- up to $700 billion
The Phillips Curve:
X and Y Axis’
X axis: unemployment
Y axis: inflation
if expected inflation increase, Phillip Curve shifts ________
up
If expected inflation decrease, the Phillips curve shifts ______
down
Milton Friedman’s commentary of Phillip Curve
this trade off is really a short run phenomenon, it’s not permanent
- in the long run, real GDP always returns to potential GDP
- which means unemployment always returns to it’s natural rate
On the Philips curve, low employment is on the __________ as opposed to the LRAS curve, where low employment is on the ____side
left side, right side
in the long run, the Phillips Curve is indeed _________ and the federal reserve can affect the _________ rate but not the _______
vertical, inflation rate, unemployment rate
