Economics 2 Modules 20, 21,23,26,27
Economics 2 Modules 20, 21,23,26,27
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Date Created: 05/02/14
Module 20 Economic Policy and the Aggregate DemandAggregate Supply Model Macroeconomic Policy 0 If aggregate output is below potential output the economy can suffer an extended period of depressed aggregate output and high unemployment before it returns to normal 0 Keynes believes the government should not wait for the economy to correct itself 0 stabilization policy use of government policy to reduce the severity of recessions and rein in excessively strong expansions 0 Typically for an economy to correct itself it will take about a decade but under stabilization policy the economy has proven to return to stability in less than ten years Policy in the face of Demand Shocks 0 Policy that short circuits the leftward shift of the demand curve is desirable for two reasons 0 Price Stability it prevents de ation O temporary fall in aggregate output is associated with high unemployment Responding to Supply Shocks O No government policies that easily remedy a supply shock O Govemments in the past decided to stabilize prices even though it would mean a higher rate of unemployment Fiscal Policy The Basics 0 changes in government spendingtaxation has large effects on the American economy Taxes Government Purchases of Goods and Services Transfers and Borrowing 0 Most government spending on transfer payments is accounted for by 3 0 Social Security 0 Medicare 0 Medicaid 0 social insurance govemment programs that are intended to protect families against economic hardship Govemment Budget and Total Spending O scal policy affects consumer spending and in some cases investment spending an increase in taxes or a decrease in govemment transfers reduces disposable income fall in disposable income leads to a fall in consumer spending rise in disposable income leads to a rise in consumer spending Govemment can use taxes transfers and purchases of goods and services to shift aggregate demand curve Expansionary and Contractionary Fiscal Policy 0 2 reasons to use scal policy to shift the aggregate demand curve 0 fill recessionary gap when aggregate output falls below potential output o ll in ationary gap when aggregate output exceeds potential output 0 Expansionary Policy Fiscal Policy that increases demand 0 increase in government purchases 0 cutting taxes 0 increase of transfers 0 Contractionary Fiscal Policy opposite of expansionary policy 0 cutting government spending purchases 0 increasing taxes 0 reduction in transfers Module 21 Fiscal Policy and the Multiplier 0 To estimate how much the aggregate demand curve will shift due to scal policy economists use the multiplier lump sum taxes amount of taxes a household owes is independent of its income How taxes affect the multiplier 0 automatic stabilizers Govemment spending and taxation rules that cause scal policy to be automatically expansionary when the economy contracts and automatically Contractionary when the economy expands without requiring any deliberate action by policy makers 0 Discretionary fiscal policy scal policy that is the direct result of deliberate actions by policy makers as opposed to automatic adjustment Module 23 The De nition and Measurement of Money The Meaning of Money 0 there lies a distinction between money and Wealth the dollar bills in your wallet are money while cars houses stock certi cates are not What is Money 0 money an asset that can easily be used to purchase goods and service 0 currency in circulation actual cash in the hands of the public and checkable bank deposits bank accounts on which people can Write checks are considered money 0 money supply total value of nancial assets in an economy that are considered money 0 existence of money increases welfare as transactions are far easier than in the barter system 0 for the barter system to work all transactions must have a double coincidence of wants Roles of Money 0 3 roles of money 0 medium of exchange an asset that individuals use to trade for goods and services rather than for consumption I ex people can t eat dollar bills They use the dollar bills to purchase edible items 0 unit of account the commonly accepted measure for setting prices and making economic calculations I the commonly accepted measure makes transactions easier 0 store of value a means of holding purchasing power over time I store of value is a necessary but not a distinctive role of money I ex if ice cream was the store of value no one would be able to use it as the ice cream would melt Types of Money 0 commodity money medium of exchange was a good gold or silver that has intrinsic value in other uses 0 commodity backed money a medium of exchange with no intrinsic value whose ultimate value was guaranteed by a promise that it could always be converted into valuable goods on demand 0 commodity backed money holds an advantage to commodity money because it ties up fewer valuable resources fiat money money that derives its value entirely from its official status as a means of exchange Fiat money has two advantages over commodity backed money 0 it doesn t tie up any real resources 0 money supply can be managed based on the needs of the economy instead of being determined by the amount of gold and silver prospectors happen to discover 0 one risk of fiat money is counterfeiting Measuring the Money Supply 0 monetary aggregates overall measures of money supply 0 2 aggregates M1 and M2 0 M1 currency in circulation cash traveler s checks and checkable bank deposits 0 M2 M1 near moneys financial assets that aren t directly usable as a medium of exchange but can be readily converted into cash or checkable bank deposits such as savings accounts 0 because currency and checkable deposits are directly usable as a medium of exchange M1 is the most liquid measure of money Module 24 The Time Value of Money The Concept of Present Value 0 Basic rule for deciding to take on a project is to compare benefits vs costs 0 However sometimes the costs may precede the bene ts ie college and tuition Borrowing Lending and Interest 0 Having 1000 today is worth more than having 1000 a year from now 0 borrowers are willing to pay interest to have money today than waiting until they acquire that money later on Defining Present Values 0 Value ofX whenr0l0 X lll009l 0 present value of 1 when r 010 is 091 0 net present value the present value of current and future bene ts minus the present value of current and future costs Module 26 The Federal Reserve System History and Structure The Federal Reserve System 0 central bank an institution that oversees and regulates the banking system and controls the monetary base Overview of 21st Century Banking System 0 creation of the federal reserve system was a response to the Panic of 1907 Crisis in American Banking at the Tum of the Twentieth Century 0 National banking regime still suffered many bank failures and nancial crises 0 Rumors that a bank had insuf cient funds would lead to bank runs Responding to Banking Crises The Creation of the Federal Reserve 0 Panic of 1907 led to creation of Federal Reserve which was given the sole right to issue currency Structure of the Fed O Consists of 2 parts 0 Board of Govemors I oversees entire system from Washington DC of ces o 12 Regional Banks I each bank serves a region providing various banking and supervisory services Effectiveness of Federal Reserve System 0 govemment started to take a hand in the system after repeated bank runs 0 created the Reconstruction Finance Corporation make loans to banks to stabilize the banking sector 0 Glass Steagall Act of 1932 increased ability of banks to borrow from the Federal Reserve commercial banks depository banks that accepted deposits and were covered by deposit insurance 0 investment banks nancial institutions that create and trade assets such as stocks and bonds not covered by deposit insurance as their actions are far more risky Savings and Loan Crisis of the 1980 s 0 savings and loans institutions designed to accept savings and tum them into long term mortgages for home buyers Financial Crisis of 2008 Long Term Mismanagement o leverage borrowed money 0 derivatives complex nancial instruments that are constructed from the obligations of more basic nancial assets 0 balance sheet effect as sales of assets by LTCM depressed asset prices all over the world other firms would see the value of their balance sheets fall as assets held on these balance sheets declined in value Subprime Lending and Housing Bubble 0 subprime lending making loans to people who didn t meet the criteria 0 securitization nancial institutions assembled pools of loans and sold shares in the income from these pools Crisis and Response 0 Federal reserve lent money to a wide range of institutions and buying private sector debt Module 27 The Federal Reserve Monetary Policy Functions of Federal Reserve System 0 Provide Financial Services 0 provides services a bank provides to customers to all banks 0 Supervise and Regulate Banking Institutions 0 Maintain Stability of Financial System 0 Conduct Monetary Policy What the Fed Does 0 federal funds market financial market that allows banks that fall short of the reserve requirement to borrow reserves from banks that are holding excess reserves 0 federal funds rate the interest rate at which funds are borrowed and lent in the federal funds market plays a key role in the modem monetary policy discount rate interest rate the Fed charges on loans open market operations the fed reserve buys or sells us treasury bills norally through a transaction with commercial banks
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