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Econ > Monetary and Fiscal Policy > Flashcards

Monetary and Fiscal Policy Flashcards

1
Q

Monetary policy is what and controlled by who?

A
  • controlled by central banks (the FED)

- they influence the level of interest rates and money supply in the economy

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2
Q

Fiscal policy is what and controlled by who?

A
  • controlled by the government
  • they decide about taxation and govt spending levels

*only fiscal policy can be used as a tool for redistribution of income and wealth

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3
Q

Money creation formula:

A

money creation = (new deposit / reserve requirement)

$100 deposit, 10% reserve requirement = $1000 new

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4
Q

Money multiplier formula

A

money multiplier = (1 / reserve requirement)

(1 / 10% reserve requirement) = 10x multiplier; $100 new deposit * 10x = $1000 new

**the smaller the reserve requirement, the greater the money multiplier

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5
Q

M1 in the US is what

A
  • M1 is “Narrow Money”
  • money in circulation and highly liquid deposits
  • notes and coins, traveler’s checks, demand deposits
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6
Q

M2 money in the US is what

A
  • M2 is “Broad Money”
  • includes M1
    plus less liquid moneys
  • savings
  • money market deposits
  • time deposits of less than $100k
  • other balances in retail money market and mutual funds
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7
Q

Credit card balances are

A
  • are not considered part of money
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8
Q

The Quantity Theory of Money

definition and formula

A
  • QTM states that total spending is proportional to the quantity of money

Quantity of money (M) * velocity of circulation of money (V) = average price level (P) * real output (Y)

M * V = P * Y

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9
Q

Money neutrality

A
  • if it “holds”, an increase in M (money supply) will increase price levels (P), but output (Y) and employment will not change in the long run
  • output will not increase by increasing the money supply
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10
Q

Demand for Money and

Motives for holding money

A
  • w/ regard for demand for money: as GDP increases, both transaction and precautionary demand increase
  • transaction-related
  • precautionary
  • speculative
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11
Q

What does the Money Demand Curve look like and what is the SR impact of increasing money supply?

A

Money demand curve:

  • x-axis: nominal interest rates
  • y-axis: quantity of money
  • MD money demand: a curved, downward sloping line - as interest rates go up, the speculative demand for money goes down (ie the returns on stocks and bonds)
  • MS money supply: a vertical line fixed at the current quantity of money

In the SR if MS increases

  • the MS curve will move to the right
  • interest rates fall
  • price levels increase
  • AD increases in SR, and so may Y
  • but in LR AD and Y will not be affected (ie the money neutrality theory)
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12
Q

Fischer Effect

what it states and the formula

A
  • states that the real rate of interest in an economy is relatively stable and changes in nominal interest rates are due to changes in expected inflation
  • which is directly related to the concept of money neutrality

Fisher Effect:
Rnom = Rreal + πe
nominal interest rate = real interest rate + expected rate of inflation over a given time horizon

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13
Q

Nominal interest rates are comprised of

A

3 components

  • required real return
  • expected inflation
  • risk premium
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14
Q

Roles of Central Banks:

A

MONETARY POLICY

  • monopoly supplier of the currency
  • banker to the govt and the banker’s bank
  • lender of last resort
  • regulator and supervisor of the payments system
  • conductor of monetary policy: influence quantity of money and credit in an economy
  • supervisor of the banking system
  • manage foreign currency reserves and gold reserves: the Reserve Bank of India sold dollars to boost the Indian rupee
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15
Q

If the nominal GDP is $10T, and money supply is $2T, according to the quantity theory of money, the velocity of money supply is:

A

M * V = P * Y

$2M * V = $10PY

V = $10PY/$2M

V = 5

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16
Q

Monetary policy objectives

A
  • maintain full employment and output
  • maintain confidence in the financial system
  • **price stability and keeping inflation in check
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17
Q

Who benefits if inflation is higher than expected?

A
  • borrowers benefit at the expense of lenders

-

18
Q

Monetary policy tools:

A
  • open market operations
  • refinancing rates (the Central Bank’s policy rate)
  • reserve requirements
19
Q

Central Bank: Open market operations

A

The objective is to increase or decrease the amount of money in circulation

Increase MS

  • buy govt bonds from commercial banks
  • this increases the reserves at private banks, they then lend money to firms and households

Decrease MS

  • selling govt bonds to commercial banks
  • this decreases private bank reserves to lend
20
Q

Central Bank: refinancing rates and policy rate

A

In general, if the policy rate is high, the amount of lending will decrease and the quantity of money will decrease
- rate high = low lending = MS decrease

  • official rate: objective to influence short and long-term interest rates
  • repo rates
  • base rate: rate that commercial banks lend to each other
  • Federal funds rate: on in the US; interbank lending rate on overnight borrowings of reserves
21
Q

What are the impacts of an increase to the Offical Rate?

  • market rates
  • asset prices
  • expectations/confidence
  • exchange rate
  • domestic demand
  • total demand
  • inflation
A
  • market rates will INCREASE
  • asset prices will DECREASE
  • expectations/confidence will DECREASE
  • exchange rate: uncertain outcome, but the domestic will appreciate, making exports unattractive
  • domestic demand will DECREASE, savings will increase, less borrowing, reduced profitability, deferred projects, investments, and hiring
  • inflation will decrease
22
Q

The factors that affect the effectiveness of a central bank:

A
  • independence from political interference
    • operationally v target-independent
    • if govt determines the appropriate level of inflation, the central bank is only operationally independent
  • credibility
  • transparency
23
Q

Exchange rate targeting:

A

some economies target an exchange rate vs targeting inflation

  • set a fixed level for the exchange rate against a major currency
  • they import inflation
  • may result in domestic interest rate and MS volatility

Pegged exchange rt: Brz Real to USD

  • if inflation is higher in US, Brz would sell dollar reserves and buy reals
  • this restricts MS and increase SR interest rates
24
Q

Dollarization

A
  • a country uses USD as its functional currency
25
Q

If the policy rate is > the neutral rate, then

A
  • then the monetary policy is contractionary
26
Q

If the policy rate is < the neutral rate, then

A
  • then the monetary policy is expansionary
27
Q

Increasing interest rates to fight inflation is not appropriate during

A
  • during a supply shock
28
Q

Monetary policy will most likely fail to stimulate growth when the economy is experiencing:
A. rapid economic growth
B. disinflation
C. deflation

A

C. deflation

  • central banks can’t cut the nominal interest rate below 0
29
Q

Quantitive easing

A
  • used when traditional policy becomes ineffective
  • used to increase MS buy assets
  • to avoid deflation
30
Q

Fiscal policy: what it is and its objective

A
  • the taxing and spending policies of the government
    Objective
  • Primary:
    - influence the overall level of AD and real GDP
  • Secondary: tied to political motive
    - distribution of income and wealth
    - allocation of resources
  • influence output through changes in govt spending and/or taxes
  • if G increases, what is the impact on Y?
31
Q

Keynesian view on fiscal policy

A
  • govt intervention is necessary to get an economy out of recession
  • believe that AD, employment, and output increase with fiscal policy
32
Q

Monetarist view on fiscal policy

A
  • believe fiscal policy offers only a temporary effect
33
Q

An increase in the budget surplus is

A
  • indicates a contractionary fiscal policy
34
Q

An increase in the budget deficit is

A
  • indicates an expansionary fiscal policy
35
Q

Automatic stabilizers

A
  • fiscal policy tool to stabilize the economy
  • help reduce the impact of a recession
  • ie social insurance and unemployment benefits
36
Q

Discretional fiscal policies

A
  • fiscal policy tool to stabilize the economy
  • changes in govt spending
  • changes in tax rates
37
Q

The desirable attributes of tax policy

A
  • simplicity
  • efficiency
  • fairness (subjective)
  • revenue sufficiency
38
Q

Fiscal multiplier

what it is and formula

A
  • explains the changes in output when there are changes in spending and taxes
  • it is inversely related to the tax rate
  • it is directly related to the marginal propensity to consume

= 1 / ( 1 - (c*(1 - t)))

c: marginal propensity to consume

39
Q

In an economy, the tax rt is 30%, marginal propensity to consume is 75%, govt spending will increase by $3B. What is the increase in AD?

A

fiscal multiplier = 1 / (1 - (c * (1 -t)))

1 / (1 - (.75 * .70) = 2.10 fiscal multiplier

$3B G * 2.10 = $6.3B increase in AD

40
Q

If G and T increase by the same amounts, then

A
  • the effect of increased G is greater than the impact of higher taxes
41
Q

Fiscal policy can be difficult to execute because of:

A
  • recognition lag
  • action lag
  • impact lag
42
Q

Easy fiscal policy Tight fiscal policy
Easy monetary policy:

Tight monetary policy:

  • the first line denotes the effect of fiscal policy
  • *the second line denotes the effect of monetary policy
  • **the third line denotes the overall effect on the economy
A

Easy fiscal policy Tight fiscal policy
Easy monetary policy: AD up AD down
**low rates, private sector demand up ** low rates, private sector stimulated
**growing private and public sector **the private sector becomes a larger % of Y

Tight monetary policy: *AD up *AD down

                                     * *high rates, private sector down                  **higher rates, private sector demand decreases 
                                     * **public spending % of Y grows                   ***shrinking private and public sectors
  • the first line denotes the effect of fiscal policy
  • *the second line denotes the effect of monetary policy
  • **the third line denotes the overall effect on the economy

Econ (7 decks)

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