Macro Final Exam

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fiscal policy

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CONGRESS & PRESIDENT
changes in FED TAXES & PURCHASES
affects NATIONAL ECONOMY thru AGGREGATE DEMAND by changing PRICE LEVEL & REAL GDP

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govt. purchases

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spending by fed. govt. on goods & services (salaries of fed. govt. agencies, purchase of aircraft carriers)
RESULT IN PROD. OF NEW GOODS & SERVICES
NO TRANSFER PAYMENTS

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govt. expenditures

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fed. govt. purchases + all other govt. spending
(1) interest on national debt (payments to holders of the bonds the fed. govt. has issued to borrow $
(2) grants to state & local govts. (payments made by fed. to support govt. activity @ state & local levels)
(3) TRANSFER PAYMENTS (Social Security, Medicare, unemployment insurance, programs to aid poor) - largest & fastest-growing category

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automatic stabilizer

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govt. spending & taxes that automatically increase/decrease along w/ business cycle
happens w/o govt. action
expansion - employment & incomes increasing, govt. spending on unemployment insurance payments decrease & govt. collection of taxes increase b/c ppl. are paying higher taxes on higher incomes
opp. for recession

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discretionary fiscal policy

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govt. takes actions to change spending/taxes

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expansionary fiscal policy

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increasing govt. purchases/decreasing taxes
increases AD
actual GDP < potential GDP
real GDP & price level rise

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contractionary fiscal policy

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decreasing govt. purchases/increasing taxes
reduces AD
actual GDP > potential GDP
real GDP & price level fall

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timing

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potential fiscal policy problem
delays caused by legislative process can be very long
even after a change has been approved, it takes time to implement

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crowding out

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potential fiscal policy problem
decline in private expenditures as result of increase in govt. purchases

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fed. govt. budget

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relationship btwn. EXPENDITURES & TAX REVENUE

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budget deficit

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govt. expenditures > tax revenue
increases during wars & recessions (b/c of automatic stabilizers: wages & profits fall -> tax revenues fall, govt. increases spending on TR; discretionary fiscal policy: increasing spending/cutting taxes to increase AD; usually takes place w/o Congress or president taking action)

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budget surplus

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govt. expenditures < tax revenue

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fed. govt. debt.

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total value of US Treasury bonds outstanding
deficit: Treasury must borrow funds from investors by selling Treasury securities, debt grows
surplus: Treasury pays off existing bonds, debt shrinks

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Fed. Reserve

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in charge of managing $ SUPPLY & INTEREST RATES (2 monetary policy targets)

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expansionary monetary policy

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FOMC orders expansionary policy -> $ supply increases & interest rates fall -> I, C, & NX increase -> AD shifts right -> real GDP & price level rise

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contractionary fiscal policy

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FOMC orders contractionary policy -> $ supply decreases & interest rates rise -> I, C, & NX decrease -> AD shifts left -> real GDP & price level fall

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real GDP

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value of final goods & services evaluated @ base-yr. prices
hold prices constant (PURCHASING POWER of dollar remains same from 1 yr. to next) which makes it a better measure than nominal GDP
greater than nominal in yrs. before base yr. & less for yrs. after base yr. & equal in base yr.
drawback - over time prices may change

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nominal GDP

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value of final goods & services evaluated @ current yr. prices

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GDP

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included: domestically prod. final goods & services (including capital goods), new construction of structures, changes to inventories (GDP = final sales + changes to inventories)
not included: intermediates goods & services, inputs, used goods, financial assets likes stocks & bonds, TR, foreign-prod. goods & services

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frictional unemployment

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short-term that arises from process of matching workers w/ jobs
low unemployment rate, periods of unemployment are shorter, suggesting most of unemployment is frictional
opp. during high unemployment rate

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structural unemployment

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arises from persistent mismatch btwn. skills & attributes of workers & requirement of jobs
last longer periods b/c workers need time to learn new skills

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cyclical unemployment

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caused by a business cycle recession

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natural rate of unemployment

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full-employment rate of unemployment
normal rate of unemployment
frictional + structural

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labor force

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sum of unemployed & employed workers in economy
BLS CLASSIFIES PPL. WHO DON'T HAVE A JOB & WHO AREN'T ACTIVELY LOOKING FOR A JOB AS NOT IN THE LABOR FORCE

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GDP deflator

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measure of price level
calculated by dividing nominal GDP by real GDP x 100
measure of avg. level of prices of FINAL GOODS & SERVICES in economy
BROADEST MEASURE OF PRICE LEVEL & may not clearly indicate how inflation affects typical household

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Consumer Price Index (CPI)

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avg. of prices of goods & services purchased by typical urban family of 4
COST-OF-LIVING INDEX

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Producer Price Index (PPI)

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avg. of prices received by prods. of good & services @ all stages of prod. process
measure prices of raw materials, intermediate goods, or final goods used by prods. instead of consumers

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consumption

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increases when: current disposable income, household wealth, & expected future income increases
decreases when: price level and interest rate increases

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investment

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increases when: expectations of future profitability & profits (cash flow) increases
decreases when: interest rate & taxes increase

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net exports

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increases when: price level in US relatively lower than other countries
decreases when: growth rate of US GDP relatively higher than other countries & when the exchange rate btwn. dollar & other currencies is more valuable in US currency

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movement along AD curve

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CHANGES IN PRICE LEVEL only affects QUANTITY OF GOODS & SERVICES DEMANDED in economy, NOT DEMAND FOR GOODS & SERVICES

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shift AD curve left

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increase in INTEREST RATES (MONETARY POLICY, raise cost to firms & households of borrowing, reducing C & I)
decrease in DISPOSABLE INCOME (INCOME + TR - T)
decrease in EXPECTED PROFITS FROM FIRMS
decrease in EXPECTED FUTURE INCOME
increase in PERSONAL TAXES (FISCAL POLICY, C falls when T rises)
increase in BUSINESS TAXES (FISCAL POLICY, I falls when T rises)
increase in VALUE OF DOMESTIC CURRENCY RELATIVE TO FOREIGN CURRENCIES (M rise, X fall -> reducing NX)
decrease in GOVT. PURCHASES
increase in growth rate of domestic GDP relative to foreign GDP (M increase > X -> reduces NX)

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shift AD curve right

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increase in govt. purchases (FISCAL POLICY)
increase in households' expectations of their future incomes (C increases)
increase in firms' expectations of future profitability from I (I increases)

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shift SRAS curve right

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DOESN'T SHIFT B/C OF FISCAL OR MONETARY POLICY
increase in labor force/capital stock (SHIFTS LRAS RIGHT; more output can be prod. @ every price level)
increase in productivity (SHIFTS LRAS LEFT, costs of prod. output fall)

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shift SRAS curve left

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increase in future price level (workers & firms increase wages & prices)
increase in workers & firms adjusting to having previously under-estimated the price level (workers & firms increase wages & prices)
increase in expected price of important natural resource (cost of prod. output rise)

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key assets on bank's balance sheet

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reserves
loans
holdings of securities (US Treasury bills)

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assets

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value of anything owned by firm

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liabilities

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value of anything firm owes
s

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stockholders' equity

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diff. btwn. total value of assets & total value of liabilities
represents value of firm if it had to be closed, all its assets were sold, & all its liabilities were paid off
CORP.'S STOCKHOLDERS' EQUITY REFERRED TO AS ITS NET WORTH

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reserves

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deposits a bank keeps as cash in vault/on deposit w/ Fed. Reserve
NOT LOANED OUT OR INVESTED
not part of currency circulation

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required reserves

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reserves a bank is legally required to hold, based on checking account deposits
banks are required by law to keep as reserves 10% of checking account deposits

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required reserve ratio

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min. fraction of deposit banks are required by law to keep as reserves

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excess reserves

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reserves that banks hold over & above legal requirement
to guard against possibility that many depositors may simultaneously make w/drawls from their accounts

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consumer loans

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households

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commercial loans

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businesses

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deposits

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banks' largest liability
checking accounts, savings accounts, & certificates of deposit

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monetary policy tools

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that Fed. uses to manage $ supply
open market operations
discount policy
reserve requirements

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open market operations

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buying & selling of Treasury securities by Fed. Reserve to control money supply

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FOMC

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TO INCREASE $ SUPPLY: directs TRADING DESK located @ Fed. Reserve Bank in NY, to BUY US Treasury securities from public; when the sellers deposit the funds into their banks, reserves rise -> starts process of increasing loans & checking account deposits -> increases $ supply
TO DECREASE $ SUPPLY: directs trading desk to SELL Treasury securities; when buyers pay for them w/ checks, reserves fall -> starts contraction of loans & checking account deposits -> reduces $ supply

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discount policy

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discount rate: rate @ which Fed. loans out $ to banks as lender of last resort
rate increased - more expensive for banks to borrow in order to meet required reserve amounts -> causes banks to be more careful about reserves, keep more reserves, & make fewer loans -> decreases checking account deposits & $ supply
when banks borrow from Fed., banks' reserves increase

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reserve requirements

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when Fed. reduces required reserve ratio, it converts required reserves into excess reserves