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VIRGINIA TECH / Economics / ECON 103 / What is the ratchet effect in macroeconomics?

What is the ratchet effect in macroeconomics?

What is the ratchet effect in macroeconomics?

Description

School: Virginia Polytechnic Institute and State University
Department: Economics
Course: Macrroeconomics
Term: Fall 2016
Tags: Macroeconomics
Cost: 50
Name: Exam 3 Study Guide
Description: This study guide covers the topics that Mike stated would be on exam 3.
Uploaded: 11/07/2016
7 Pages 12 Views 10 Unlocks
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Exam 3 Study Guide 


What is the ratchet effect in macroeconomics?



Test Date: 11/11/16

Ratchet Affect (4)

∙ Ratchet effect: (democratic thinking) once prices go up, they never go down o Ratchet: works only in one direction

o Due to ratchet effect, what takes a hit in a recession?  output  (income, jobs, etc.)

Phillips Curve (1)

∙ Phillips curve:  

o Phillips – famous economist from CA

o Always a tradeoff between solving inflation vs solving unemployment  o Was he right? – NO, only true in joint range

o If you solve one, you exacerbate the other

Laffer Curve (2)  


What is meant by fiscal policy?



∙ *Lower tax rate: 85%  80%: more tax revenue (more people work) o Not true for left of hump

∙ Higher tax rate more money goes to Washington

o Laffer: under certain circumstances, not necessarily

∙ At what point would tax rates be so high that people don’t work? – top of the  hump

Stagflation (6)  

∙ Stagflation – rising unemployment simultaneous with rising prices ∙ D  A on curve Don't forget about the age old question of biol 3060

∙ Oct 1973: OPEC countries control oil (4x price of petroleum products: gas,  

rubber, paint, etc.)

o Oil-dependent companies:

 Fired people

 Raised prices

Presidential Policy (1)  

∙ Of the 44 presidents, 43 have focused economic policies on manipulating the  We also discuss several other topics like How did the bus boycott create a mass movement for change?

aggregate demand curve (cut taxes, etc)

∙ Reagan enacted economic policies to increase supply: lower cost of  

production

o Cut business taxes : passed largest corporate income tax cut in U.S.  history – 72%48% (24% cut)


What are the roles of money?



Fiscal Policy (4)  

∙ Fiscal policy = the taxing and spending powers of government If you want to learn more check out aaron childs mcmaster
We also discuss several other topics like what system of long distance communication that connected all the intellectuals of the west?

If you want to learn more check out arth 72 sjsu

∙ Horizontal = Keynesian range

∙ Vertical = classical range ( government stays out – flexible) ∙ Joint range – trade-off

∙ AD goes up from AD5  AD6  inflation (classical range)

∙ If increase AD1  AD2, there are 4 outcomes:

o 1. Prices and wages stay the same

o 2. More output

o 3. More jobs

o 4. More income

Roles of Money (4)  

∙ 5 roles of money (what does money do?)

o 1. Medium of exchange: more efficient than bartering  

o 2. Store of value: nominal face value is constant

o 3. Standard of value: facilitates comparison (shopping); quality vs  

price

o 4. Social invention: human idea; money only works if there is  

confidence in it; man-made object We also discuss several other topics like What is iconography?

o 5. Convertibility: until 1971, all money was convertible; prior to 1971,  anyone could go to the bank and give money in exchange for gold or

silver (money said “Silver Certificate” instead of “Federal Reserve  Note”) – The Gold Standard

Definition / Types of Money (1)

∙ Types of money (14):

o M-1 = coins + currency + demand deposits (checking and now  

accounts)

o M-2 = M-1 + savings + small time deposits (CDs) + mutual funds +  

money market accounts

o Don’t need to know the rest

o *TEST: Each level includes all prior levels (up to M-14)

Demand for Money (2)  

∙ Demand for money (3 main reasons):

o Transactions: everyday spending

o Precautionary: savings for emergency

o Speculative: long-term investments

Money Creation (7)  

∙ When banks make loans

∙ Creation ≠ printing 

∙ Inflation low  expansionary 

∙ Inflation high  contractionary 

o Raise discount rate 

o Raise r (required reserves) 

∙ *Excess Reserves = loanable funds = “$ created”

o M = 1/r = 1/.1 = 10

o Excess funds = M * (excess reserves at Bank A)

o 40,000 enables 360,000 loans

o In reserve = in your bank’s vault or in a bigger bank’s vault  rest can  

be invested

o Banks don’t HAVE to loan out bank money

∙ If the fed buys bond, money is pumped into economy  

∙ If the fed buys a bond, money is taken out of nation’s reserve and put into  economy

Interest Rates (4)

∙ Tool #2: Discount Rate

o 1. Federal Funds Rate: rate of interest charged between commercial  banks on overnight loans to comply with required reserves (r);  

“targeted” by the fed, not “set” by the fed

o 2. Discount Rate: rate of interest charged by the fed on large loans to  

large banks  

o 3. Prime Rate: rate of interest charged by large commercial banks to  

their best customers (big businesses)

o 4. Consumer Rate: rate of interest charged on regular loans to regular  people (college, home, vacation, etc.); consumer rate = prime rate +  more

Open Market Operations (1)  

∙ Fed tool #3: Open Market Operations (buying/selling bonds; “going to the  

window”)

o Most commonly used tool by the fed

Price:

$1 Million (face Value)

$380,000 $395,000

Issued by: _________________ Maturity Date: _____________ Owner(s): _________________ ____________________

____________________

∙ Rule of 72: 72/rate of interest = 72/6% = 12 years

∙ Why would the fed buy a bond? – mechanism for the fed to pump money into  the economy or withdraw it

∙ If the fed buys bond, money is pumped into economy  maturity date:  

money withdrawn

∙ *TEST: When the first purchaser buys a bond, does it increase the nation’s  

money supply?  

o NO; regular citizen; just transfer of money

∙ If the fed buys that bond, money is taken out of nation’s reserve and put into  

economy

∙ The fed buys and sells bonds all the time

o The Fed DOES NOT issue bonds

∙ Why would the fed buy bonds? – if inflation was low

∙ If inflation is high, the fed will sell bonds it purchased in the past Monetary Policy (5)  

∙ Most powerful man (woman) in America: Chair of the Federal Reserve = Janet  

Yellen 

∙ Managing the nation’s money supply is more important than the president’s  

job

∙ Raising interest rates by just .25% makes a big difference

∙ Every country has a central bank (U.S. = Federal Reserve = “Fed”) ∙ When Mike says “the fed,” he means Federal Reserve

∙ Functions of the Fed:

o Supervises commercial banks

o Issues (not prints) currency

o Holds reserve accounts for large banks

o Processes checks

∙ Fed bank = quasi governmental agency

o Each fed bank manages banks in 4 to 5 states

 12 in USA (Richmond, VA)

o Quasi – person does not report to president (like supreme court) ∙ Tool #1: Required Reserve Ratio ( r )

Bank

Original Deposit

Required Reserves

Excess Reserves

A

40000

4000

36000

B

36000

3600

32400

C

32400

3240

29160

400,000

40,000

360,000

Assume: r = 10%

∙ *Excess Reserves = loanable funds = “$ created” = increase in money supply o M = 1/r = 1/.1 = 10

o Excess funds = M * (excess reserves at Bank A)

o 40,000 enables 360,000 loans

o In reserve = in your bank’s vault or in a bigger bank’s vault  rest can  

be invested

o Banks don’t HAVE to loan out bank money

o How much money can be spent in the scenario? - $400,000 (40,000  

+360,000)

∙ Tool #2: Discount Rate (see Interest Rates)

∙ Tool #3: Open Market Operations (see Open Market Operations)) Greider Book (1)  

∙ William Greider: Secrets of the Temple: How the Federal Reserve Runs the  

Country”

o 800 page argument on how the Federal Reserve manipulates the  

world’s economy 

∙ Managing the nation’s money supply is more important than the president’s  job

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