Unit 5: Monetary and Fiscal Combinations: Economic Policy in the Real World
* Macroeconomic policy involved combinations of fiscal and monetary policies.
* The interactions between monetary and fiscal policies can affect overall aggregate demand. For example, a tight monetary policy combined with an expansionary fiscal policy can cause “crowding out.”
* “Crowding out” is the effect of a rise in interest rates caused by increased borrowing by the federal government. The higher interest rates “crowd out” business and consumer borrowing.
* A Phillips curve illustrates the inflation unemployment tradeoff and how this tradeoff may differ in the short and long run.
* Both monetary and fiscal policies are primarily aggregate demand policies, but not all of the macroeconomic problems in the economy are aggregate demand problems.
* If factors other than excess aggregate demand are contributing to inflation, it is difficult for monetary and fiscal policies to deal with them.
* Economic growth is concerned with increasing an economy’s total productive capacity at full employment or its natural rate of output. This output is represented by a vertical long-run aggregate supply curve.
* Economic growth is usually measured by changes in real GDP or by changes in real GDP per capita.
* Economic growth can be shown graphically as a rightward shift of a nation’s long-run aggregate supply curve or a rightward shift of its production possibilities curve.
* The Keynesian model is based on the belief that fiscal policy works through aggregate demand. Government fights unemployment by increasing aggregate demand and fights inflation by decreasing aggregate demand. Monetary policy works through interest rates and investment and also affects aggregate demand.
* The rate of economic growth is affected by a variety of aggregate supply and demand factors.
* The classical model represents an idealized version of a private-enterprise economy in the long run. In terms of aggregate demand and supply, the classical model is characterized by a vertical aggregate supply schedule, which is a function of tastes, technology, society’s resource base, and the distribution of economic resources, and an aggregate demand schedule that is a function of real money balances. Supply-side factors determine real output and employment. Aggregate demand and supply together determine the price level.
* The monetarist model, which is closely related to the classical model, focuses on the importance of changes in money supply on the economy. The monetarists’ basic analytical device is MV=PQ. Monetarists favor a monetary rule calling for a constant rate of change in the money supply that coincides with changes in real GDP.
* The rational expectations model, which is also closely related to the classical model, maintains that economic agents are intelligent decision makers and can be expected to take the effects of government policy changes into account in deciding their behavior. Because agents anticipate changes in policies, these policies will have no effect on read GDP.
* Supply-side economics emphasizes factors that cause the aggregate supply curve to shift. Supply-side economists argue that the inflation and stagflation are caused largely by decreases in aggregate supply-not by changes in aggregate demand. They recommend microeconomic solutions such as improved productivity and less government regulation.
* Different economic theories are only one reason why economists disagree; other reasons are disputes about time periods, different assumptions, and different values.
Tuesday, March 31, 2009
Friday, March 20, 2009
Unit 4 Key Ideas
To accomplish its functions, money should have certain characteristics which include portability, uniformity, acceptability, durability, divisibility, and stability in value.
Throughout history, there have been four basic types of money: commodity money, representative money, fiat money, and checkbook money.
Money has three main functions- as a medium of exchange, a standard of value, and a store of value.
Economists often disagree about what money is. M1 is the narrowest definition and consists of checkable deposits, traveler’s checks, and currency. Checkable deposits are called demand deposits and account for about 75% of M1.
M2 and M3 are broader definitions of money and include savings accounts and other time deposits.
MV=PQ is the equation of exchange; money times velocity equals price times quantity of goods. PQ is the nominal GDP.
Velocity is the number of times per year the money supply is used to make payments for final goods and services: V=GDP/M
Money is created when banks make loans. One bank’s loan becomes another bank’s demand deposit. Demand deposits are money. When a loan is repaid, money is destroyed.
Banks are required to keep a percentage of their deposits are reserves. Reserves can be currency in the bank vault or deposits at the Federal Reserve Banks. This reserve requirement limits the amount of money banks can create.
The money multiplier is equal to one divided by the reserve requirement. 1/rr
The higher the reserve requirement, the less money can be created; the lower the reserve requirement, the more money can be created.
The Federal Reserve, or “Fed,” regulates financial institutions and controls the nation’s money supply. The three main tools that it uses to control the money supply are: changing the discount create, changing the reserve requirement, and buying and selling government bonds on the open market (open market operations).
If the Fed wants to encourage bank lending and increase the money supply, it will decrease the discount rate, decrease the reserve requirement, and buy bonds on the open market. The Fed expands the money supply to fight unemployment. This is called an expansionary monetary policy or an “easy money” policy.
If the Fed wants to hold down or decrease the money supply, it will discourage bank lending by increasing the discount rate, increasing the reserve requirements, and selling bonds on the open market. The Fed discourages bank lending during inflation. This is called a contractionary monetary policy or a “tight money” policy.
The reserve requirement is the most powerful tool of monetary policy; it is rarely used because of its power. Open market operations are the most frequently used tool because they permit the Fed to make small changes in the money supply.
Monetarists believe that money directly affects the economy through the equation of exchange. Monetarists believe the money supply should be increases at the rate of three to five percent a year, exactly the same amount as the increases in real GDP.
Keynesians believe that money affects interest rates and that interest rates, in turn, affect investment and GDP. Tight money increases interest rates, which decrease aggregate demand, which helps fight inflation. Easy money decreases interest rates and increases GDP during recessions.
The Fed cannot target both the money supply and interest rates simultaneously so it must choose which goal to attempt to achieve.
Throughout history, there have been four basic types of money: commodity money, representative money, fiat money, and checkbook money.
Money has three main functions- as a medium of exchange, a standard of value, and a store of value.
Economists often disagree about what money is. M1 is the narrowest definition and consists of checkable deposits, traveler’s checks, and currency. Checkable deposits are called demand deposits and account for about 75% of M1.
M2 and M3 are broader definitions of money and include savings accounts and other time deposits.
MV=PQ is the equation of exchange; money times velocity equals price times quantity of goods. PQ is the nominal GDP.
Velocity is the number of times per year the money supply is used to make payments for final goods and services: V=GDP/M
Money is created when banks make loans. One bank’s loan becomes another bank’s demand deposit. Demand deposits are money. When a loan is repaid, money is destroyed.
Banks are required to keep a percentage of their deposits are reserves. Reserves can be currency in the bank vault or deposits at the Federal Reserve Banks. This reserve requirement limits the amount of money banks can create.
The money multiplier is equal to one divided by the reserve requirement. 1/rr
The higher the reserve requirement, the less money can be created; the lower the reserve requirement, the more money can be created.
The Federal Reserve, or “Fed,” regulates financial institutions and controls the nation’s money supply. The three main tools that it uses to control the money supply are: changing the discount create, changing the reserve requirement, and buying and selling government bonds on the open market (open market operations).
If the Fed wants to encourage bank lending and increase the money supply, it will decrease the discount rate, decrease the reserve requirement, and buy bonds on the open market. The Fed expands the money supply to fight unemployment. This is called an expansionary monetary policy or an “easy money” policy.
If the Fed wants to hold down or decrease the money supply, it will discourage bank lending by increasing the discount rate, increasing the reserve requirements, and selling bonds on the open market. The Fed discourages bank lending during inflation. This is called a contractionary monetary policy or a “tight money” policy.
The reserve requirement is the most powerful tool of monetary policy; it is rarely used because of its power. Open market operations are the most frequently used tool because they permit the Fed to make small changes in the money supply.
Monetarists believe that money directly affects the economy through the equation of exchange. Monetarists believe the money supply should be increases at the rate of three to five percent a year, exactly the same amount as the increases in real GDP.
Keynesians believe that money affects interest rates and that interest rates, in turn, affect investment and GDP. Tight money increases interest rates, which decrease aggregate demand, which helps fight inflation. Easy money decreases interest rates and increases GDP during recessions.
The Fed cannot target both the money supply and interest rates simultaneously so it must choose which goal to attempt to achieve.
Monday, March 16, 2009
Common Mistakes On The AP Macro Exam
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Common Mistakes On The AP Macro Exam
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