LM 3&4: Monetary & Fiscal Policy Flashcards
What is the difference between monetary policy and fiscal policy?
Monetary policy is used by the central bank to influence the quantity of money and credit.
Fiscal policy relates to the government’s taxation and spending to impact the economy
What is the difference between Keynesian and monetarists?
Keynesians: believe fiscal policy can greatly affect aggregate demand, output, and employment
Monetarists: believe that fiscal policy has only a temporary impact on aggregate demand and that monetary policy is the most effective means of addressing inflationary pressures.
What is the difference between expansionary policy and contractionary policy?
expansionary policy: boost the economy by increasing spending
contractionary policy: slow down economy by cutting back on spending
What is government deficits?
difference between government revenues and expenditures over a time period
What is a barter economy?
pay for goods and services with other goods & services
What 3 important functions does money fulfill? MSM
- Medium of Exchange (used to purchase goods and services)
- Store of Value (money is valuable)
- Measure of Value (measure value of all goods & services)
What is a promissory notes?
promissory note is a written promise by one party to make a payment of money at a date in the future
What is fractional reserve banking?
practice of lending money based on assumption all customers wont want their money back at the same time (if so leads to bank runs)
What is the total deposits formula?
initial deposit / reserve requirement = total deposits
What is the money multiplier formula?
MM = 1 / reserve requirement
What is the formula for total money available at the end using the money multiplier?
total money available at end = initial deposit * money multiplier
What is the quantity theory of money and formula?
general price level of goods and services is proportional to the money supply in an economy
M×V=P×Y
M: is the quantity of money
V: is the velocity of money
P: is the average price level (average price of transactions)
Y: is the real output (total number of transactions)
What are 3 reasons people hold money? TPS
- Transactions-related balances
- Precautionary balances
- Speculative balances
What is nominal rate of interest formula?
refers to the interest rate after taking inflation & real interest rate into account
i = (1+real interest rate) * (1+inflation rate) -1
By increasing money supply it allows people to:
buy more goods & services
What is the fisher effect and formula?
Fisher effect states the real rate of interest is stable. Changes in the nominal interest rate are a function of expected inflation
Rnom=Rreal+πe
What are the 7 roles of central banks? SBLRCSM
- Supplier of Currency
- Banker to Government and Bankers’ Bank (commercial banks)
- Lender of Last Resort (print money)
- Regulator of Payments System
- Conductor of Monetary Policy
- Supervisor of the Banking System
- Maintain Foreign Currency Reserves and Gold Reserves
What are 3 objectives for central banks implementing monetary policy? SMM
- stable prices
- maximum employment
- moderate long-term interest rates
Where does wealth shift from in an unexpected inflation environment?
wealth transfer between borrowers and lenders
What are the 3 monetary tools used by central banks? OCR
- Open Market Operations
- Central Bank’s Policy Rate
- Reserve Requirements
Describe the 3 monetary tools used by central banks? OCR
- Open Market Operations (involve the purchase and sale of government bonds from commercial banks) (buys bonds in the open market, it increases the money supply)
- Central Bank’s Policy Rate (changing interest rates to increase or decrease money supply)
- Reserve Requirements (central bank can reduce the money supply by increasing the reserve requirement)
What is the base rate?
reference rate on which a commercial bank bases lending rates to all customers
What is the discount rate/ repo rate?
rate at which member banks can borrow from the federal reserve system
What is the Fed Funds rate?
the target interest rate set by the Fed at which commercial banks borrow and lend their extra reserves to one another overnight.
What are three key factors that are important in determining whether a central bank can successfully implement an inflation target? CCT
- Central Bank Independence
- Credibility
- Transparency
What is the Fed’s statutory mandate?
maximum employment, stable prices, and moderate long-term interest rates
What is the goal of targeting a specific exchange rate?
targeting an exchange rate = targeting the inflation rate of foreign economy
What is a currency peg?
a fixed exchange rate target from another country
domestic currency’s value is pegged to the value of a foreign currency.
What is dollarization?
USD replaces the national currency
What is Contractionary policy vs Expansionary policy?
contract = less money supply, less spending more saving (lower inflation)
expansion = more money supply, more spending less saving (higher inflation)
What is the neutral policy rate for an economy?
=
real trend rate of growth in the economy
+ long-run expected inflation
rate at which monetary policy is neither contractionary nor expansionary
What is the difference between demand shock and supply shock?
demand shock is a sudden unexpected event that dramatically increases or decreases demand for a product or service
supply shock is an unexpected event that changes the supply of a product or commodity, resulting in a sudden change in price.
What is quantitative easing?
fed deciding to print money and put it in circulation
What is fiscal policy?
uses government spending and taxation to impact economy
What is expansionary fiscal policy?
encourage spending
What is government deficits formula?
government deficits = government expenditures - government revenues
What does a too high of a ratio of national debt to GDP mean?
questions the solvency, country could become insolvent if too high
What are the 3 forms of government spending? TCC
- transfer payments (welfare payments)
- current government spending (health, education)
- capital expenditure (roads, hospitals, schools)
What are direct taxes vs indirect taxes?
Direct taxes come from income, wealth, and corporate profits
Indirect taxes include excise duties on fuel, alcohol, tobacco, and other items.
What are the 4 desirable attributes of a tax policy? SEFR
- Simplicity (not easily manipulated)
- Efficiency (should not discourage work or investment or interfere with personal choices)
- Fairness (this is subjective, but most want the rich to pay more)
- Revenue sufficiency
What is the fiscal multiplier and formula?
determine how much output will change when government spending or taxation changes
1 / [(1 - c) (1-t)])
c= marginal propensity to consume (MPC)
T= tax rate
What is marginal propensity to consume (MPC)?
measures how much more individuals will spend for every additional dollar of income
What is recognition lag vs action lag vs impact lag?
recognition lag: takes time for data to indicate the economy is slowing.
action lag: takes time to implement
impact lag: measures how long the actions take to impact the economy.
