Fiscal Policy Flashcards
Fiscal Policy
The government’s attempt to counter fluctuations in aggregate expenditure with changes in purchases, transfer payments, or taxes
Expansionary Fiscal Policy
Involves increasing government purchases, increasing transfers, or decreasing taxes in order to shift AD to the right and boost real GDP
Contractionary Fiscal Policy
Involves decreasing government purchases, decreasing transfers, or increasing taxes in order to shift AD to the left and decrease real GDP
Government Spending Multiplier
Government Spending Multiplier = 1/MPS
Tax Multiplier
Indicates the total change in real GDP resulting from each $1 change in taxes (Tax Multiplier = -(MPC/MPS))
Balanced Budget Multiplier
Combination of both the Government Spending Multiplier and the Tax Multiplier (Equal to 1)
Crowding Out
The decrease in real investment stemming from higher interest rates due to government purchases
Partial Crowding Out
When the effect of crowded-out investment on real GDP is smaller than the initial increase in real GDP due to purchases
Complete Crowding Out
When the decrease in investment eliminates the entire boost in real GDP from increased purchases
Monetary Policy
The use of money and credit controls to influence interest rates, inflation, exchange rates, unemployment, and real GDP
Expansionary Monetary Policy
Increasing the money supply or lowering the interest rate
Contractionary Monetary Policy
Decreasing the money supply or raising the interest rate
Money
Anything that is commonly accepted as a means of payment for goods and services
Commodity Money
Has value beyond its usefulness as money
Flat Money
Has no other value besides being money
Medium of Exchange
Allows for money to be traded
Double Coincidence of Wants
Means that a person who owns the goods or services you want has a desire for what you have to barter with
Store of Value
Ability of money to store a set value
Unit of Account
Ability of money to set prices based off its value
Money Supply Aggregates
M0: Cash
M1: M0 + Checking Deposits and Traveler’s Checks
M2: M1 + savings deposits, small time deposits, money market mutual funds, and Eurodollar deposits
Fractional Reserve Banking System
Only a fraction of total deposits are held on reserve and the rest is lent out
Reserve Ratio (rr)
Reserve Ratio = Bank Reserves/Total Deposits
Balance Sheet (T Account)
Shows the activities of a bank
Money Creation
Ability of banks to increase the money supply as they loan money out to people, who will put it into other banks
Money Multiplier
Money Multiplier = 1/rr
Discount Rate
The interest rate banks pay to borrow money from the Fed (As it decreases, banks borrow more and increase the money supply)
Open Market Operations
Involve the Fed purchase and sale of government bonds (As bonds are sold, money is taken out of circulation, decreasing the money supply)
Liquidity Trap
Changes in the money supply will have no effect on interest rates
Equation of Exchange
Money Supply times Velocity equals the average Price times Quantity (MV = PQ)
Velocity of Money
The number of times per period that the average dollar is spent on final goods and services
Quantity Theory of Money
States that both V and Q are stable, meaning increases in M affect P
Real Interest Rate
Real Interest Rate = Nominal Interest Rate - Anticipated Inflation
Nominal Interest Rate
Nominal Interest Rate = Real Interest Rate + Anticipated Inflation
Natural Rate of Real Interest
Fluctuations in the nominal interest rate simply reflect changes in anticipated inflation
Fisher Effect
States that if market participants can predict that the Fed will counter inflation by reducing money supply growth, anticipated inflation and nominal interest rates will begin to fall when the Fed tightens the money supply
