Week 7 Flashcards
How can the effects of fiscal policy be shown?
The effects of changes in fiscal policy can be shown using AD-AS, LFM, K cross, and IS-LM.
How can the effects of monetary policy be shown?
The effects of changes in monetary policy can be shown using AD-AS, the model of money supply and demand, the Market for Real Money Balances and the IS-LM.
What’s monetary policy?
Monetary policy is the control of the money supply.
This is typically controlled by central banks rather than the government.
In May 1997, the UK government decided to delegate power over monetary policy to the Bank of England and the Monetary Policy Committee (MPC) was established.
What’s the role of commercial banks in the economy?
They assess the riskiness of borrowers and allocate financial resources effectively.
They engage in maturity transformation.
They direct funds to areas that yield the highest funds.
What are the monetary policy tools for central banks?
The policy rate
The use of open market operations
The adjustment of banks’ reserve requirements.
What’s the policy rate?
The policy rate is the rate at which commercial banks can borrow from / save with the central bank.
Commercial banks borrow from the central banks because the central bank acts as a ‘lender of last resort’.
Commercial banks save with a central bank because it’s safe.
The policy rate influences the interest rates that commercial banks offer to their customers (positive relationship).
What are open market operations?
Open market operations refer to the purchase and sale of non-monetary assets from/to the banking sector by the central bank.
What are reserve requirements?
The reserve requirements stipulate that banks must hold a particular amount of money in the reserve, limiting the extent to which banks can give out loans.
What are nominal and real interest rates?
The nominal interest rate (i) is the rate of interest offered by commercial banks.
The real interest rate (r) is the nominal interest rate corrected for inflation: r = i - Pi.
If i > Pi, the purchasing power of money held rises.
If i < Pi, the purchasing power of money held falls
What were the two hypothesis as to what caused the great depression?
The spending hypothesis (Keynesian view)
The money hypothesis (Friedman and Schwartz)
What’s the spending hypothesis?
The spending hypothesis asserts that the GD was due to an exogenous fall in demand for goods and services (a leftward shift in the IS curve).
The stock market crash of 1929 caused an exogenous decrease in C.
The 1920s saw “overbuilding”, which was corrected for in the 1930s.
There was contractionary fiscal policy (a decrease in G).
What’s the money hypothesis?
The money hypothesis asserts that the GD was due to a huge fall in money supply (a leftward shift in the LM curve).
What are the problems with the money hypothesis?
P fell even more than M, meaning that M/P (real money supply) actually rose slightly rather than falling.
Nominal interest rates fell, whereas we expect a rise in interest rates from a leftward shift in LM.
What’s the alternative money hypothesis?
An alternative money hypothesis: the GD was due to huge deflation which followed from the decrease in money supply.
In this second take on the MH, expectations are important.
As a decrease in the money supply has a negative effect on prices, if P decreases unexpectedly:
Purchasing power transfers from borrowers to lenders (arbitrarily).
Borrowers spend less, lenders spend more.
If lenders’ marginal propensity to spend is less than borrowers’, aggregate spending (c) falls, IS shifts to the left, and Y falls.
How can the central bank respond to an increase in government spending?
It can hold M constant.
It can hold r constant.
It can hold Y constant.
