LM5: Monetary and Fiscal policy Flashcards
What is the Quantity theory of money equation?
MV = PY, where M = quantity of money, V = velocity of money circulation, P = price level, Y = real output
What is the neutrality of money theory?
the neutrality of money is an idea that any change in the money supply makes no difference to real economic variables. Real interest rates, employment, real consumption, or GDP (gross domestic product), for example, are real economic variables.
What is the demand for money?
The demand for money is the amount of money individuals in an economy wish to hold at a particular time. Bonds, treasury bills, or treasury certificates are not included in the theory of the demand for money. The demand for money is motivated by three main reasons. These reasons are the pillars behind individuals’ desire to hold liquidity (money), and they include:
What are the three motives for demanding money?
transaction motive: people hold money because they need it to carry out business and financial transactions;
precautionary motive: money is held as a precaution against uncertainty. In other words, people desire to hold money in preparation for any emergency that might befall them; and
speculation motive: here, money is held in anticipation of a future decline in the prices of assets or goods and services. Holders of money in such an instance aim at benefiting by purchasing assets, goods and services at cheaper prices.
What is the Money Transmission Mechanism?
The monetary transmission mechanism is the process where general economic conditions and asset prices are affected due to the monetary policy decisions. It occurs through interest rate channels that influence the costs of borrowing, the levels of investment, and aggregate demand. The transmission mechanism is characterized by long-time lags
What is the equation for the Fischer effect?
Rnom = Rreal + πe
where Rnom= nominal interest rate, Rreal= real interest rate, πe= expected inflation rate
What are 3 tools to implement monetary policy?
Open market operations (OMO): Buy/Sell government bonds which leads to increase/decrease in commercial banks’ reserves, to increase/decrease money supply
Central bank’s policy rate: If policy rate is high, amount of lending will decrease -> Quantity of money will decrease
Reserve requirements: If reserve requirement is low then the money multiplier goes up and money supply increase
What are the equations for the required reserves ratio and the money multiplier?
What is contractionary monetary policy?
(reducing money supply and/or increasing interest rates) helps cool off an ‘overheating’ economy with high inflation due to high economic growth.
What is expansionary monetary policy?
(increasing money supply and/or reducing interest rates) helps boost a slowing economy.
What are the two key limitations of monetary policy?
Central banks cannot control how much households save.
Central banks cannot control banks’ willingness to lend and hence expand credit.
What is contractionary fiscal policy?
(reducing government spending and/or increasing taxes) helps control inflation in a high growth economy.
What is expansionary fiscal policy?
(increasing government spending and/or reducing taxes) helps boost aggregate demand in a slowing economy.
What are the 3 types of fiscal spending?
What are the 2 types of fiscal revenue?
What is the fiscal multiplier equation?
MPC = marginal propensity to consume, t= taxes
