Macroeconomics: Price Levels (Inflation) & Fiscal/Monetary Policy Flashcards
What is the primary purpose of consumer price index (CPI)?
Measure and compare relative price changes over time. It does so by relating prices paid for a basket of goods and services during a period to the prices of those goods and services in a prior base period.
The strength of an economic recovery would be measured primarily by what?
Real GDP
What indicator does the federal government use to measure inflation?
Consumer Price index (CPI)
What is inflation and deflation?
Inflation - annual rate of increase in the price level
Deflation - annual rate of decrease in the price level
What is CPI-U?
The Consumer Price Index for all urban consumers (CPI-U) is the most common yardstick used by the federal government to measure inflation or deflation in the U.S.
The CPI-U measures the change in the price of a “basket” of consumer goods and services over time. The rate of change in that price measures inflation (or deflation).
What is consumer confidence index (CCI)?
Measure the confidence of consumers in the economic outlook.
Between wages, sales, interest expense, and depreciation, which one of these would inflation not have an impact on?
Depreciation. Depreciation does not reflect current fixed-asset replacement costs. Depreciation is the systematic and rational allocation of long-term assets over the period benefited. Thus, depreciation (expense) reflects the portion of the historical cost of the asset allocated to the current period.
Why are wages, sales, and interest expenses reflective of current rates?
Wages reflect current labor rates. Sales reflect current product prices. Interest expense reflect current borrowing rates. All of these are recognized in the current period at the current rates. Inflation causes each one of these to increase.
What is the formula to calculate percentage changes for account balances? This would be use to compare to different years.
(Current balance - prior balance) / prior balance.
What is the formula to calculate for GDP Deflator?
(Nominal GDP/Real GDP)x100= GDP Deflator
How do you solve for Nominal GDP, Real GDP, or GDP Deflator?
Use GDP deflator formula and solve for the particular variable you are trying to determine. For example, if you need to solve for real GDP, but are given Nominal GDP or GDP Deflator, use the formula to solve for real GDP.
Why would someone on fixed income be impacted and hurt by increase in inflation?
An increase in inflation will result in goods and services costing more and, because the increase is unanticipated, consumers would not have prepared by adjusting investments or spending patterns. This person won’t be able to consume as many goods & services with inflation increases.
Which of the following is correct regarding the Consumer Price Index (CPI) for measuring the estimated decrease in a company’s buying power?
The products a company buys should differ from what a consumer buys. The Consumer Price Index (CPI) measures the change in price over time of a representative “basket” of goods and services purchased by consumers, not by companies.
When given principal amount, interest rate, and inflation rate, how do you determine the worth of something after inflation?
Formula: Principal + Interest Amount (Interest rate x principal)/Inflation rate + 1
When consumer prices increase because of increases in aggregate demand, what also increases as well/
Quantity of output.
How does deflation impact interest rates?
Decreases interest rates
What does producer price index measure?
The price of a basket of commodities at the point of the first commercial sale. It measures the combined price of a selected group of goods and services for a specified period in comparison with the combined price of the same or similar goods for a base period.
How does inflation effect price and purchasing power?
Increases price. Reduces purchasing power.
What does GDP include?
The total monetary value of all final goods and services produced within a nation in one year.
What are some characteristics of a deflationary economy?
- Potential GDP > Actual GDP
- Low Interest rates
- Consumers are hesitant to make purchases w/ declining prices
- Companies are hesitant to make investments
What are some characteristics of an inflationary economy?
- Companies will make investments
- Consumer spending is higher
- Higher interest rates
- Actual GDP > Potential GDP
What does CPI measure?
Rate of inflation
The most effective fiscal policy program to help reduce demand-pull inflation would be to?
Increase taxes and decrease government spending
Who establishes fiscal policy and who establishes monetary policy?
Federal Reserve system establishes monetary policy. U.S. Congress establishes fiscal policy.
What actions are taken in fiscal and monetary policy?
Fiscal - Government Spending
Fiscal - Taxes
Monetary - Money Supply changes
What are some federal reserve policies that would increase the money supply? (Expansionary)
- Decrease reserve requirement
- Reduce discount rate
- Purchasing treasury bonds
- Purchasing federal securities
- Decrease in margin requirement
What are some federal reserve policies that would decrease the money supply? (Contractionary)
- Increase reserve requirement
- Increase discount rate
- Sell U.S. Treasury bonds (Reduce loans and reserve requirements)
- Selling federal securities
- Increase in margin requirement
What is the discount rate?
The discount rate is the interest rate banks pay when borrowing from a Federal Reserve Bank (the “Fed”). By reducing the discount rate, the cost of borrowing is reduced and banks increase lending, which increases the money supply.
What is a reserve requirement?
The reserve requirement is the amount (expressed in a percentage) that a bank must hold in reserve for every dollar loaned by the bank.
What is the most effective way to halt inflation?
Increasing interest rates by a large amount. These would increase the cost of business investments and consumer spending on durable goods (homes, cars, etc.), which would decrease demand for those forms of expenditures and thereby reduce demand. Reduced demand would lower prices.
A government is most likely to reduce taxes on investments when?
Low capital spending. A reduction in taxes on investments (i.e., an investment tax credit) and/or a reduction in taxes on gains from investments (i.e., capital gains) would increase the return to investors and thus spur capital spending.
M1 measure of money supply includes what?
Paper currency, coin currency, and check-writing deposits
M2 measure of money supply includes what?
All M1 Items (paper and coin currency, check-writing deposits) + savings deposits, CDs (
M3 measure of money supply includes what?
All M1 Items: Paper and coin currency and check-writing deposits
All M2 Items: Savings deposits, etc.
CDs (>$1,000), institutional mutual funds
What does an expansionary policy seek to achieve? What is opposite policy to expansionary?
An expansionary policy would serve to increase spending, demand, employment, and other economic measures. Contractionary.
What is the formula to calculate velocity of money?
VM=GDP/Money Supply (MS)
What is the best preventative measure in a period of deflation? Explain why?
Increasing Money Supply. When an economy is in deflation, increasing the money supply (for example, by lowering the reserve requirement or, in most circumstances, lowering the discount/interest rate) will stimulate demand and increase the general price level. It’s all about shifting demand curve up to increase prices.
When a country reduces its rate of monetary growth, what are several effects on country’s economy?
- Lower GDP
- Higher interest rates
- Decrease in investments and consumer spending (results of higher interest rates)
- Lower net exports (country’s goods are more expensive)
Government borrowing to finance large deficits would have the following effect?
Upward pressure on interest. This is because demand for investments funds would increase as a result of government borrowing. Therefore, borrowers would have to pay higher interest rates.
If a government were to use only fiscal policy (expansionary) to stimulate the economy from a recession, it would?
- Lower taxes
2. Increase government spending
What would constitute contractionary fiscal policy?
- Higher taxes
- Lower government spending
Results in surplus.
Why would an expansionary fiscal policy have a negative effect on net exports?
An increase in governmental spending causes an increase in domestic interest rates and international capital inflows. These capital inflows cause the domestic currency to appreciate, which has a negative effect on net exports.
What would create pressure on a foreign currency to appreciate relative to the U.S. dollar?
Higher demand for foreign goods would increase the demand curve for foreign goods resulting in higher foreign prices. Example: Higher U.S. preferences for Japanese goods would create higher demand for Japanese goods shifting prices upwards.
What would a central bank do to address a short-term speculative rise in worldwide value of domestic currency?
Sell domestic currency in foreign exchange market. This would increase supply and decrease price.
What is the Federal Reserve System’s reserve ratio?
The specified percentage of a commercial bank’s deposit liabilities that must be deposited in the central bank
Define discount rate.
Rate the central bank charges commercial banks for loans.
Federal Reserve raises the discount rate, what is likely to occur?
Short-term interest rates will likely increase. An increase in the discount rate (i.e., a bank’s cost of borrowing) tends to increase the rate banks charge for loans, which tends to have a ripple effect on interest rates charged by others.
What are the four most effective policies to prevent inflation when economy is at business cycle peak?
- Reduce Gov. Spending (Fiscal)
- Increase taxes (Fiscal)
- Reduce money supply (Monetary)
- Increase interest rates (Monetary)
What relationship does interest rates have with demand of money.
Inverse. Higher interest rates decreases demand for money
What instrument of monetary policy is the most important means by which the money supply is controlled?
Open market operations through bond sales and purchases are flexible (government securities can be purchased or sold in large or small amounts), cause prompt changes in bank reserves, and are more subtle than reserve ratio changes.
