Unit 5: Inflation and Unemployment Flashcards
The Budget Balance (DEF.)
The difference between the gov.’s tax revenue and its spending, both on goods and services and on gov. transfers, in a given year
Budget Balance Equation
Gov. Savings= tax revenues- gov. purchase- value of gov transfers
Sgov=T-G-TR
A budget surplus is…
A positive budget balance
A budget deficit is…
A negative balance
Budget Deficit almost always rises when…
Unemployment rate rises
Budget Deficit almost always falls when…
Unemployment falls
Expansionary Fiscal Policies make…
Budget surplus smaller or deficit bigger
Ex. Gov purchases of goods/services, increase gov transfers, decrease taxes
Contractionary Fiscal Policies…
Increase budget balance making surplus increase and deficit decrease
Ex. Decrease in gov purchases, decrease in gov transfers, and increase taxes
2 Misleading things about Fiscal Policy
- 2 difference changes in fiscal policy that have equal effects on the budget balance may have unequal effects on economy
- Changes in budget balance are themselves the result, not the cause, of fluctuations in the econ. (Sometimes)
Relationship between budget balance and business cycle
Recession- deficit
Expansion- surplus
Cyclically Adjusted Budget Balance
An estimate of what the budget balance would be if real GDP were exactly equal to potential output
Should Budget be Balanced?
NO!
- gov should only balance budget on average, it should be allowed to run deficits in bad years, offset by surpluses in good years.
- shouldn’t be forced to run balanced because would undermine role of taxes and transfers as autostabalizers
Gov. Debt
The accusation of past budget deficits, minus past budget surpluses
What does the gov do when it runs budget deficit
Most always borrows extra funds
Fiscal Year
Runs from Oct 1 to Sept 1 and is labeled according to the calendar in which it ends
Public Debt
Gov. Debt held by indiv. And institutions outside the gov
2 reasons to be concerned when a gov runs persistent budget deficits
- When the econ is at potential out put and gov borrows finds in the financial markets, its competing with firms that plan to borrow finds for investment therefore, the gov’s borrowing may crowd out private invent. Spending- increase interest rates and redice Econ’s long run rate of growth
- Today’s deficits place financial pressure on future budgets
Debt- GDP Ratio (DEF.)
The gov debt as a % of GDP
- good indicator or potential taxes the gov can collect
Implicit Liabilities
Spending promise and by gov that are effectively a debt despite the fact that they’re not included in the usual debt statistics
- largest is medicare and social security
- 3rd largest- Medicaid
The Federal Reserve can decrease interest rate by…
Increasing money supply
The Federal Reserve can increase interest rate by…
Decreasing money supply
Open Market
Purchase/sale of treasury bills
An open market purchase…
Drives interest rate down
An open market purchase…
Drives interest rate up
Expansionary monetary policy
Monetary Policy that increases aggregate demand
- increases money supply- decreases interest rate- increases invest. Spending- increases consumer spending- increases AD- shifts to right
Contractionary Monetary Policy
Monetary policy that decreases aggregate demand
- decreases money supply- raises interest rates- lowers investment- decreases consumer spending- decreases AD- shift to left
2 goals of policy makers
Ensure price stability and fight recessions
Taylor Rule for Monetary Policy
Rule for setting the fed finds rate that takes into account both the inflation rate and output gap
- take into account inflation and business cycle
Fed Funds Rate=
1+(1.5Xinflation rate)+(.5Xoutput gap)
Monetary Policy is preferred because…
Fed moves faster than congress
Inflation Targeting
Occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target
Main difference between John Taylor’s rule and inflation target
Taylor rule adjust monetary policy in response to past inflation, but inflation target is based on forecasts of inflation
Pros of Inflation targeting
- Reduces econ uncertainty because public knows objective of inf. Targeting
- Success can be judged by seeing how closely actual inflation rates have match inf. Target.
Cons of Inflation targeting
- too constrictive
In the long run changes in the quantity of money…
Affect the aggregate price level but doesn’t change real aggregate output or the interest rate
An increase in money supply decreases interest rate and increases aggregate demand…
But the eventual rise in nominal wages leads to a fall in in short-run aggregate supply and aggregate output decreases back to potential output.
Only long-run Effect of an increase in money supply is an…
Increase in aggregate price level from P1 to P3
Monetary Neutrality
Changes in the only supply have no real effects on the economy
- MONEY IS NEUTRAL IN THE LONG RUN
An increase in money supply interest rate in short run…
In long run increases prices leads to increase in money demand and increase interest rate to original level
In the long run, changes in the quantity of money affect what?
Aggregate Price Level
An increase in money supply leads to what in the short run?
Increase in aggregate demand
A 10% decrease in money supply will change the aggregate price level in the long run by…
10%
Monetary neutrality mean as that in the long run changes in money supply…
Have no real effect on econ
A graph of percent increase in the money supply and average annual increase in the price level for various countries provides evidence that…
Money in neutral in the long run
Classical Model of the Price Level
The real quantity of money is always at its long-run equilibrium level
Inflation Tax
A reduction in the value of money held by the public caused by inflation
Cost-Push Inflation
Inflation that’s caused by a significant increase in the price of an input with economy wide importance
Demand-Pull Inflation
Inflation that is caused by an increase in aggregate demand
The real quantity of money is…
Equal to M/P and the money supply adjusted for inflation
In the classical model of the price level
Both the short and long-run aggregate supply curves are vertical
The classical model of the prive level is most applicable in….
Periods of high inflation
An inflation tax is…
The result of a decrease in the value of money held by the public
Revenue generated by the gov’s right to print money is known as…
Seigniorage
Short Run Phillips Curve (DEF)
The negative short-run relationship between the unemployment rate and the interest
- lower unemployment tends to lead to higher inflation and vise versa
When unemployment rate is low interest rate is
High
When unemployment rate is high interest rate is
Low
Long Run Phillips Curve
Shows relationship between unemploy. And inflation after expectation of inflation have had time to adjust to experience
Non Accelerating Inflation Rate of Unemployment (NAIRU)
The unemployment rate at which inflation doesn’t change over time
Debt Deflation
The reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation
Expected deflation affects…
Nominal interest rate
Zero bound (DEF)
On the nominal interest rate: it can’t go below zero
Liquidity Trap
A situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound
The long Run Phillips Curve is…
Verticle
The short Run Phillips curve shows a —— relationship between ——-
Negative
Unemployment and interest
An increase in expected inflation will…
Shift the short run Phillip curve upward
Bringing down inflation that has become embedded expectation is called…
Deflation
Debt deflation is…
The reduction in aggregate demand arriving from the real burden of outstanding debt caused by deflation
According to classical model of price level prices are…
Flexible, making the aggregate supply curve vertical even in the short run
Great Dep. showed economists cant ignore…
Short run
Keynes car Comparison
Getting econ running required only modest repair not complete overhaul
Keynesian economics…
Focuses on the ability of shifts in aggregate demand to influence aggregate output in short run
Macroeconomic Policy Activism
The use of monetary and fiscal policy to smooth out the business cycle
Liquidity Trap
Situation in which monetary policy is ineffective because the interest rate is down against the 0 bound
A sale of bonds by Fed…
Raises interest rates and redices money supply
A reduction in interest rates due to an increase in the money supply will shift…
Aggregate demand to the right
According to the classical model of price level, an increase in the money supply will create…
Inflation with no long-Run increase in real GDP
Government’s right to print money to finance deficits is referred to as….
Seigniorage
Economy is recessionary gap should do what?
Expansionary Fiscal Policy
- cut taxes, increase transfers, increase gov spending
Economy in inflationary gap should do what?
Contractionary Fiscal policy
- increase taxes, decrease transfers, decrease gov spending
Fed is now chaired by…
Jerome Powel
Adam Smith- Self-Interest
Market is driven by self-interest, people’s impulse to fulfill their own needs
- society is better because of it
Invisible Hand
Acting in self-interest
- Adam smith
Says Law
Supply creates its own demand