Week 5 Flashcards
Multiplier formula
1/(1-b*(1-t)+m)
Real Interest rate calculation
Real interest rate= nominal interest rate- inflation
Five factors determining the supply of loanable funds
- real interest rate
- disposable income
- expected future income
- wealth
- default risk
Effects of government budget surplus on SLF and DLF
Increases the supply of loanable funds.
Real interest falls, decreasing household saving and decreases supply of q of private funds. The lower real interest rate increases the q of loanable funds demanded and increases investment
Government budget deficit & its effects
G>T
Deficit increases demand for loanable funds.
The real interest rate rises, which increases household saving and increases q of private funds supplied. But the higher real interest rate decreases investment and the quantity of loanabe funds demanded by firms to finance investment
Definition monetary financial institution
Financial firm that gets most of its funds by taking deposits from households and firms
Four economic benefits provided by monetary financial institutions
- create liquidity
- pool risk
- lower the cost of borrowing
- lower the cost of monitoring borrowers
Four functions of a Central Bank
- Provides banking services to government and commercial banks
- Lender of last resort for commercial banks
- regulates and controls financial institutions and financial markets
- Conducts monetary policy (goals: price stability and inflation) through
Open Market Operations
Bank Rate Policy
Two types of monetary policy discussed
- Open market operations: selling and buying government bonds to or from banks
- Bank rate policy, together with the required reserve ratio, thereby manipulating the interest rate
Money depends on
- The price level P (positive relation)
- The nominal interest rate i (negative)
- Real GDP YR (positive)
- Transaction cost for withdrawing money TC (positive)
Classical “quantity theory” of money
MV=PT
Six ways the amount of money can change
- Open market operations
- Balance of Payments
- Financial transformation
- Government expenditure
- Changes to the Bank Rate
- Changes to required reserve ratio
Current Account formula
CA=X-M
Capital and financial account (KA) records
Receipts from the sale of assets to foreigners (investment by foreigners in our country), and
the payments for assets to foreigners (investment by our country in foreign countries).
KA categorization based on surplus and deficit
KA surplus: net international borrower KA deficit (KA< 0) net international lender
Change in official reserve assets
A decrease of (reserve) assets is the same as becoming more of a net borrower
An increase of (reserve) assets is the same as becoming less of a net borrower
Two aggregate supply curves
- Short-term (SAS): (upward sloping, and up-/downward shifting)
This shows how supply changes in the period that the general
price level and wages DO NOT move in sync. - long-term (LAS) (vertical, and left-/right shifting)
This shows the maximum, potential supply of an economy,
given the technology and amount of production factors
Four factors aggregate depends on (& which make it shift)
- price level
- worl economy
- expectations
- fiscal policy and monetary policy
2-4 : shift the AD curve
Fiscal and monetary policy which one is and which one is not keynesian
fiscal : keynesian
Monetary: non-keynesian
Wealth effect
A rise(fall) in prices decreases(increases) the real value of wealth (remember: wealth is a stock variable). As a consequence, more(less) saving will be channeled to maintaining wealth (remember: saving is a flow variable). Since more(less) saving implies less (more) expenditure, the result follows:
Rising prices imply
falling aggregate demand
(and falling prices imply rising demand)
Reasons for AD curve sloping downward
- wealth effect
2. substitution effects
AD curve and Keynesian policy
remember: keynesian policy is fiscal policy
An increase in G or T will increase expenditure and shift AD to the right
AD curve and monetary policy
expansionary monetary policy:an increase in Ms
An increase in Ms will lower the interest rate, which increases expenditures, and shifts AD to the
right.
AD & world economy
activity will raise the foreign demand for “our” goods… that means exports will rise.
As the AE curve shifts ** UP **, the
AD curve shifts ** RIGHT **
Three schools of macroeconomic thought
- classical view: economy is self-regulating and always in full employment
- Keynesian view: economy rarely functions at full employment, active help from fiscal and monetary policy required
- monetarist view: economy is self-regulating, normally functioning at full employment as long as monetary policy is not erratic
Classical view and its policy recommendations
A classical economist believes that the economy is self-regulating and that is always at full employment
best policy is nothing!
AS-AD graph: LAS and AD
Keynesian view and its policy recommendaton
Keynesian economist thinks that the economy rarley operates at full employment and that to achieve and maintain full employment active help from fiscal and monetary policy is required
Policy: activist macroeconomic policy almost always needed
AD curve shifts erratically and wages are sticky so SAS does not shift up and down easily
AS-AD graph: SAS, LAS and AD
While the “Keynesian View” also accepts using monetary
policy to manage the economy, the “Keynesian Model” simply
can’t… There is no “money” in the Keynesian Model
Monetarist view and its policy
economy is self-regulating, it will work at normal employment as long as monetary policy is not erratic and the pace of money is kept steady
Policy: no activist monetary policy
the quantity theory of money (YP=MV) as Y= (M/P)*V
Supply-side view
supply potential of an economy is what determines growth. (opposite to Keynesian idea)
Policy suggestion: supply-side view pushes the idea that stimulating business activity is the key - lower corporate taxes - promote the formation of human capital - stimulate investment - de-regulate the economy AS-AD graph: SAS, LAS and AD
Debtor nation
state that during its entire history has borrowed more from the rest of the world than it has lent to it
creditor nation
state that has invested more in the rest of the world than other states have invested in it
Flows & stocks
flows: borrowing and lending
stocks: debts
Four big problems of deflation and inflation
- wealth redistribution
- income redistribution
- lowering real GDP and employment
- diverts resources from production
Consumer Price Index
CPI: measure of the average of the prices paid by consumers for a fixed basket of goods and services
Long-run Aggregate Supply
Money wage rate changes in step with the price level to maintain full employment
LAS curve = vertical as potential GDP is independent from price level
Short-run Aggregate Supply
when money wage rate, prices of other resources and potential GDP remain constant
Change in price level brings change in q of real GDP supplied -> movement along SAS curve
Three reasons for an increase of potential GDP
- increase in full employment quantity of L
- increase in quantity of capital
- advance in technology
Consequences for SAS and LAS from change in money wage and other resource prices
- SAS curve shifts, rise in money wage rate decreases SAS
- LAS curve remains the same as the change in money wage rate is accompanied by an equal percentage change in price level
Two reasons for a change in money wage rate
- departures from full employment
2. expectations about inflation
Four main factors determining buying plans
- price level
- expectations
- fiscal policy
- world economy
Main factors of changes in AD
- expectations: increase in expected future disposable income increases the amount of consumption goods that people plan to buy today and increases AD today
- fiscal policy and monetary policy
fiscal policy: government’s attempt to influence the economy by setting and changing taxes, making transfer payments and purchasing goods and services
monetary policy: changes in interest rates and in quantity of money in the economy
Three types of short-run equilibria
- above full-employment equilibrium: real GDP exceeds potential GDP
- full employment equilibrium: real GDP equals potential GDP
- below full-employment equilibrium: potential GDP exceeds real GDP
Reminder: potential GDP is intersect LAS with AD
Stagflation
combination of inflation and recession
Reaction SAS and consequences of situation with higher energy/transport costs
Firms decrease production -> SAS shifts leftwards
-> price level rises & real GDP decreases (economy experiences recession)
Neo-classical view
business cycle fluctuations are efficient response of well-functioning market economy bombarded by shocks that arise from uneven pace of technological change
Herd instincts
expectations are most significant influence on AD
New Keynesian view & its policy
money wage rate & prices of goods/ services are sticky. With sticky price level, SAS curve horizontal at price level
Fiscal and monetary policy to actively offset changes in AD that bring recession -> stimulating AD in recession can restore the full employment
