Mac Econ Finale

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  1. Fiscal Policy
    The counter cyclical use of gov't spending and taxation powers to stabalize the economy
  2. Employment act
    • 1946
    • Federal gov't has responsibility to maintain full employment with stable prices.
    • This act created the economic councle of advisors
    • Fallow up was Humphrey Hawkins act
  3. Ressecionary gap
    • Economy in recession then increase gov't spending and reduce taxes
    • Actual GDP is below potential.
    • To the left of Yxp
  4. Inflationary Gap
    • Economy is beyond capacity then decrease gov't spending and incrase taxes
    • Actual GDP is above potential
    • to right of Yxp
  5. How to fix Ressecionalry gap
    • Use expansionalry fiscal policy
    • Must increase G
    • Change in Y = Change in G * Me
    • Me is slope from Consumption function.
    • This incrase in G with close the recesionary gap
  6. Costs of Fixing Recesionary gap
    • Anticipateion of higher taxes
    • Deficit and debt
    • Inflation and lower real wages
  7. Benefits of fix Ressecionary Gap
    • GDP up so stimulte growth in economy
    • Unemployment goes down
  8. Suppose lower taxes
    • Taxes opporate through households
    • It will opporate throught the consumption function
    • C = 300 + .6y - T
  9. Tax Multiplier
    • Mt = - MPC/1-MPC
    • Me > Mt
  10. How much to lower taxes?
    • Change in Y = Mt * change in T
    • The negative number means we would have to lower taxes by that much to get to full employment
  11. Problems with Activist fiscal Policy
    • 1) Time Lags: the political process can interfear and bog down
    • 2) Actual size of Multiplier: due to inflation and high interest rates
    • 3) The Political business cycle: politicians won't dow hat is neeeded for the economyh in an election year
  12. Automatic Fiscal Stabilizers
    • 1) Progressive tax system
    • 2) Unemployment insurances- if strong then pays taxes
  13. The Deficit
    • Budget surplus = T - G - TR
    • TR = Tax revenue
    • If T > G + TR then Positive BS
    • If T < G + TR then Negative BS ( deficit)
  14. The Debt
    • The money the gov't borrows to finance the deficit
    • The Gov't borrow by selling bonds, treasury bills, treasury notes
    • Debt is sum of deficits
  15. Argument for balancing budget
    • 1) Deficits cause inflation
    • 2) Deficts cause high interest rates that crowd out private investment
    • 3) Deficits cause high interest rates that crowd out Nx
    • 4) Sound finance argument
    • 5) The burden argument
  16. If we push AD past capacity (right)
    This results in negative cyclical unemployment so there are jobs and employee's demand higher nominal wages which puts it back at equilibrium but at a higher price level which is inflation
  17. High interest rates...
    • Appreciate the ]dollar relative to other currencies. Foreigers want to invest in foreing secruites so that puts pressure on dollare and price of dollar rises
    • Therefore cost of Nx goes up so reduces SAles abroad
  18. Coutner arguments
    • For 1,2,3: it depends on where we are in the business cycle
    • If we are below full employment inflation and crowding out is less of a problem
    • For 4,5: depends on what the defecxt and debt purchase like bridges (role of gov't)
  19. Funcitonal Finance
    • Balance the duget over the business cycle
    • What drives the debate today is libertain view that governemnt should be radically reduced
    • Starve the beast
  20. Financial System
    • 1) Reduce trasactions costs: get together so can made a deal in limiting debt
    • 2) Reduce financial risk: provide differenet typs of investment which allows to spread out to diff kinds
    • 3) To provided liquid assests: assest easiliy turned into cash
  21. 4 Main types of financial assets
    • Loans
    • Bonds
    • Stocks
    • Bank Deposits
  22. Main types of Financial intermediaries
    • 1) Mutual Funds
    • 2) Pension Funds
    • 3) Life insurance
    • 4) Banks
  23. Mutual Funds
    These create stock porfolios and sell shares in those portfolios to individuals
  24. Pension Fund
    Type of mutual fund which holds assets to p;rovide for retirement
  25. Life Insurance
    Life insurance guarentees payments to beneficiaries when the policy holder dies
  26. Banks
    Provide liquid assets based on band deposits to finance the spending needs of borrowers
  27. The efficient Market hypotheiss
    • Eugene Fama
    • It argus that asset prices will in the long run reflect their true value, due to the assumption that people are rational.
    • If people are tarional they will use all avialable info to evaluate value of assets. As a result, asset prices will reflect value
  28. What is money?
    • An asset that can easily be used to purchase goods and services
    • Consists of cash and other things that are highly liquidible
  29. 3 Types of money
    • 1) Commodity money
    • 2) Commodity backed money
    • 3) Fiat money
  30. Commodity money
    • The medium of exchange is a good
    • gold and silver
  31. Commodity backed money
    Paper currency issued that is backed by gold or silver
  32. Fiat Money
    • Money whose vaulue derives entirely from it's status as the official currensy
    • U.S. $ is fiat money
  33. The functions of money
    • 1) Medium of exchange
    • 2) Unit of account
    • 3) Store of Value
  34. Medium of Exchange
    • Money facilitates the exchange of goods by eliminating the double concidence of wants.
    • paying for somthing in exchange for somthing
  35. Unit of Acount
    Money is the standard of value in which we express the value of all goods and services
  36. Store of value
    • Money holds purchsing power oaver time
    • Money is a unit through which we express future values
  37. Measues of Money
    • The federal reserve calcutes to measues of money
    • 1) m1: currency in circulation + travelors checks + chekcing (demand) demands
    • 2) m2: m1 + savings deposstis + small time deposties ( CD < 100,000) + mutual funds
  38. Commercial banks
    • 2 Primary functions:
    • 1) Hold demand depsoties and honor checks drawn on the deposites: helps trades take place
    • 2) Make loans, lend money: important to facilitate investment int he private sector
  39. The Fractional reserve
    Becaues banks are only required to hold a portion of total deposites on reserve
  40. To ensure conficence in bank
    • 1) Deposit insurence (FDIC ensures depostis up to 250000)
    • 2) Capital requirements: capital = assets - deposits
    • 3) Reserve requirements: rules set by the fed establishing the iminimum reserves, 10 % min
    • 4) The discount window: The federal reserve will provide loans to banks that are in trouble
  41. Fraction Reserve banking and Creation of Money
    • Assume:
    • 1) The fed sets reserve ration =.2 (required reserves)
    • 2) No bank in the system holds excess reserves
    • 3) No cash reserves are ever leaked out of the systme
  42. Demand Deposit Multiplier
    1/Reserve ratio
  43. DDM Dependable on
    • 1) No leakage of cash from the banking system
    • 2) Banks do not hold excess reserves
    • 3) The willingness fo the individual actors to borrow and lend
  44. The Federal Reserve System
    • Federal reserve is the central bank of the U.S
    • Established in 1913 in respons to serices of financial panics
  45. Functions of the FED
    • 1) Control the money supply
    • 2) To serve as a lnder of last resort
    • 3) Check clearing facilities for the banking systems
    • 4) Issue currency
    • 5) Act a s a fiscal agent for the Fed (gov't assist in making purchases)
    • 6) Supervices and regulates the finacial sector
  46. The Structure of the Fed
    • Board of Governs
    • FOMC
    • 12 Districts
    • Board of Directors
  47. The board of Governers
    • 7 Members appointed by the president approved by senate
    • 14 year terms
    • Every 2 years a new member comes on
  48. FOMC
    • Federal Open market committee
    • 12 member; 7 board of governer, 5 district bank presidents
    • New Yourk District bank is permanent mameber
  49. Board of Directors
    • Banks in private sector
    • 1 selected in ach istrcit to serve on the board
  50. Monetary Policy
    • A major funcito of the fed is to control the money supply for:
    • 1) price stability
    • 2) to attain "full employment"
  51. Tools for Monetary Polity
    • 1) Reserve requirements
    • 2) Open market poerations
    • 3) the discount rate
  52. Reserve Requiremennts
    • If the Fed reduces teh reserve requiremnt theyn the money supply would increaset
    • Banks able to loan more money
  53. Open Market operations
    • The primay means by which the fed influences the money supply
    • The FOMC buys and sells bonds in the opne market
    • If the FOMC puchases bonds, the money supply will incdrease
  54. Discount Rate
    • If the Fed lowers the discount rate, it signals that it will increase the money supply
    • If the Fed increases the disount rate, it siganls that it will decrease the money supply
  55. The Federal funds rate
    The rate banks charge each other for overnight loan
  56. The Reconstruction Finance Corporation (RFC)
    • 1932
    • was established and given authority tomake loans to troubled banks.
  57. The Glass-Stegall Act passed
    • 1932
    • created federal deposit insurance
    • Increased the ability of banks to borrow from the Fed
    • Seperated banks into two categories:
    • Commercial (covered by deposit insurance)
    • Investment (less regulated and allowed to trade in more risky financial assets)
  58. Regulation Q
    • Prevented banks from paying interest on checking accounts.
    • Argued it would lead to unhealthy competition.
  59. Depository Institutions and Deregulation and Monetary Control Act
    • 1980
    • Removed Regulation Q.
    • Allowed S & L’s to offer checkable deposits.
  60. Gar st. Germain Depository Institutions Act
    • 1982
    • Allowed S & L’s to undertake riskier investments (i.e., real estate development).
    • With deregulation S & L’s faced a profit squeeze. Due to paying higher rates on deposits. At the same time they were locked into long-term fixed mortgages (though this legislation allowed new loans to have
    • adjustable rates).
    • Facing a profit squeeze, and with questionable regulatory oversight, S & L’s undertake risky investments that did not pay off.
    • S & L’s begin to fail. Over 1,000 S & L’s closed between 1986-1995. costing tax payers $124 billion.
  61. The Financial Services Moderization Act (Gramm-Leach-Bliley Act).
    • 1999
    • Eliminates Glass-Stegal rules that separate investment and commercial banks.
    • Exempts financial derivatives (i.e., credit default swaps) from regulation.
    • Note:
    • Joseph Stiglitz argues this legislation allowed the risk-taking culture of investment banking to overtake the conservative culture of commercial banking.
  62. The Policy Response
    • ThevTroubled Assets Relief Program TARP—Allowed the U.S. Treasury to purchase or insure up to $700 billion of ‘troubled assets.”
    • The American Recovery and Reinvestment Act—2009.
    • The Dodd-Frank Wall Street Reform and Consumer Protection Act—2010
  63. The Dodd-Frank Wall Street Reform and Consumer Protection Act
    • 2010
    • Increasescapital requirements of investment banks.
    • Regulatesderivatives (must be traded on exchanges). This repeals exemptions made under Gramm-Leach-Bliley Act).
    • Creates“Bureau of Consumer Financial Protection” within the Federal Reserve.
  64. Monetary theory: Classical model
    • Money is Neutral
    • It only affects prices, and does not affect employment and output
    • Depict Quantity theory using the equation of exchange
  65. The Equation of Exchange
    • Ms * V = P * Y
    • Y= real GDP
    • P = Price level
  66. Quantity Theory assumes
    • 1) Ms is exogenour ( its determend by the central bank)
    • 2) Assumes velocity is contsnt because of peoples spending habits are stable
    • 3) People demand money to carry out transactions
    • 4) Y (GDP) is at potential so economy is self adjsuting
  67. In terms of AD and AS model
    • Is is pure inflation where if money is increased, then price is increased in full proportion
    • Moves AD right which just increases price
  68. Policy for this
    • Early monetarists: argued for the gold standard, commodity backed money linked to gold
    • Later monetarists: argued for policy rule
    • Early example policy rule was milton freedment who argued fed should incrase money supply as same rate GDP was increaseing
  69. Keynesain Liquidity preference theory of money
    • Keynes like the nometarist saw that poeple demand moeny for transaction purposes.
    • In addition, keynes argued that people also demand money for specualate purpose
  70. The Speculative Demand for Money
    • Money is viewed as an alternative form of wealth
    • An alternavie asses tha is part of a a finacial portolio
    • If money is an asset thent ehre is an opportunity cost to holding money. that opportunity cost is therate of recuts on the other assets (bonds)
  71. In terms of graph
    • Indierect relationship
    • If the real rat of interest is low, then there is a high demand for money
    • If iterests rate low then people hold money because opportunity cost of holding it is lower
  72. Determeinets of Money demand
    • 1) Changes in the price level
    • 2) changes in teh real GDP
    • 3) Technology changes
    • 4) Changes in instituition
  73. Price level increases...
    MD shifts right becasue more money demanded at every price level becase price increased
  74. Money Market equilibrium
    • Above equilibrium: surplus so interset rates should fall to clear market
    • Below equilibrium: md>ms, shortage so upward pressur on interest ratses
  75. The Fed incrases Money supply
    Ms Shifts to the right, surplus so downward pressure on interst ratse
  76. Liquidity Preference Theory
    • Regarding why interst rates fall whent he fed increases the omeny supply
    • the fed increses ms peole how now hold more money, people will increase their demand for bonds
    • this increases demand for bonds, increse price of bonds and if price of bonds increases then interst rate on bonds will fall
  77. Present Value theory of Asset Pricing
    PV= FV/(1 + r)
  78. Monetary Policy and Aggregate damand
    • Keynesiand transmisson mechansim:
    • Suupose the fed increases ms (purchanse bonds in open market)
    • This will make consumption move up and stimulate ad out to right and ms move out to right
  79. Non neutral money
    • Output and employmebnt afffected
    • Money supply increases to rates down, so consumpution and investment increase and Ad increates so potential increases
  80. Monetarist and the rate of interest
    • An increase in the money suply will not change the real rate of interst due to inflation formula
    • r = i -rate of inflation
  81. Monetary Policy in Practie
    Have historically argued for an activits central bank
  82. The Taylor Rule
    • Developed by John Taylor
    • In seetting monetary policy, the fed should target the federal funds rate, keeping inflation and ouptu in mind by taking account of both inflation and output
  83. Federal Fujds RAte
    • 1 + 1.5* inflation + .5*output Gdp
    • If actual GDP above potential then RFF increase so FRR would reduce moeney to dool down
    • If Actual GDP below potential then reduce RFF which would increase money suppl
  84. Inflation Targeting
    • Central Bank targets only inflation and strives to keep a very low rate of inflation
    • Argument:
    • 1) It is more transparent (can better judge what is going to be forward looking)
    • 2) This promotes a greateer accoutnability becasue you can judge if cnetal bank has achieve its target
  85. New classical ecomics
    • Emerged in the 1970 as critique of keynesian ecoomics and policy
    • 1) Milton Feedmen -"fooling" or natural rae model
    • 2) Rober Lucas- rational expectaions model
    • 3) Fin Kydland and Edward prescott- real business cycle model
  86. The Natural RAte of fooling model
    • Assume:
    • 1) Workers mispercieve movement in the price level
    • 2) The economy is at capacity (unemployment = naturea)
    • 3) Policy makers do not recogine the natual rate of unemploymebnt
  87. Equilibrium in Macro econ
    • In long run economy will adjust to effeicndet equilibuium
    • SRAS acknolege price rigidity and that actual GDP can differ
    • The polidy maker swant to sitmualte AD to reduce uneimployment and grow GDP. Policy would increase Ms, or down tax up g
  88. If Fed increses ms so AD shift right
    • Go to point b becasue workers have been fooled.
    • They see the incres in nominal wage but bno tin price, so they don't see real wage is acually lower
    • Over time they catch on, the demand and SRAS shifts up and back to potential
  89. Rational Expectaions
    • Assumes
    • 1) both employuers and workers can mispercieve movment in the price level
    • 2) both the eoplyers na d woreker aer rational wehre ratiaonality incidcate the contiually seek all availabe info in ordder to acccuraely predict movement in the price level
  90. In terms of graph
    • Same graph
    • At point B both workers an demplyer are mispercieveing. workers daony see fall in real ages whild employers don't see fall in real profi
    • Over time woerkes and employers see the rise in prices and sras shifts up
  91. Friedmenn (fooling model)
    The economy moesv from A to B becasue workers are fooled. they dont see their real wagtes falling
  92. Rational expecations
    • the econly moves from A to B becaseu both workers and emplyers mispercieve prices
    • also it is possible both can form rational expecatiosn that accuratly prdice movemtn in the price leve. if this occures then economy moves ffrom a to c
  93. The real busiiness cycle theory
    • Assumes:
    • 1) Prices are fully flexiable (no rigidity)
    • 2) Fluctuations in output are due to changes in real GDP
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Mac Econ Finale
Mac Econ Finale
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