| A | B |
|---|
| Store of Money | an item that one can use to transfer purchasing power from present to future |
| Unit of account | yard stick to post prices and record debt |
| Medium of Exchange | What is used to buy goods/services |
| Wealth | total of all stores of value (money and nonmonetary) |
| Liquidity | the ease of which an asset can convert to the medium of exchange |
| Commodity Money | intrinsic value has value when not used as money ie: gold |
| Gold Standard | When currency can be converted into gold on demand |
| cigarettes have been used as______in Russia and POW camps | Store of value, medium of exchange, unit of account |
| Fiat Money | Money w/o intrinsic value has value because government has decreed it has (people must have faith it does) |
| Money Stock | Quantity of money circulating in the economy |
| Examples of M1 | Deposits, Travelers checks, Currency |
| Examples of M2 | Savings, small time deposits, money market funds |
| Federal Reserve has 3 main functions | regulate health of banking system, control money supply, loan money to banks |
| Federal Open Market Committee (FOMC) | Makes monetary policy and increases/decreases money supply (helicopter/vacuum) |
| Open-Market Operation | purchase or sale of gov't bonds |
| how does the fed increase money supply? | Creates dollars and purchases Gov't bonds from public in bond market (public has new money) |
| How does fed decrease money supply? | Fed sells gov't bonds that it owns, the money that is used for purchase is now out of hands of public |
| what happens if the gov't prints too much money? | Prices rise (inflation) |
| What is Reserves? | Deposits that banks recieve but don not loan out |
| What is a T-account? | Simplified accounting statement that show's the banks assets/liabilities |
| if banks hold all deposits in reserve what happens to the money supply? | The money supply remains unchanged |
| Fractional Reserve Banking | banking sys. holds only a fraction of deposits in reserve while lending the rest for a profit (interest) |
| what is the reserve ratio? | the fraction of deposits the bank holds in its vault |
| if a bank has a 10% reserve with a 100.00 deposit how much would be loaned? what is the total liability? what is the money supply amount? | 90.00/100.00/190.00 |
| When banks hold a fraction in reserve what happens to the money supply? | It increases (banks create money but not wealth) |
| what is the money multiplier | The amount of money generated with each dollar of reserves (ratio of deposits to reserves) |
| If R is the reserve ration for all banks, then each dollar of reserve generates? | 1/r dollars of money (ex: r=10%) then 1/10 |
| if the reserve ratio were 1/20 then the banking system would have 20x more _____than_____ | deposits/reserves (money multiplier of 20) |
| If reserve ratio were 1/5 then the deposits would be _____more than reserves with a money multiplier of____ | 5x / 5 |
| The higher the reserve ratio the ____money banks loan out | less |
| If a bank has a 100% reserve, does it lend out money? | No |
| Can banks create money in a fractional reserve system? | Yes |
| What tools does the fed use in monetary control? | open-market operations, reserve requirements, discount rate |
| when the fed buys bonds to increase money supply which creates more money? keeping it as currency or depositing it in bank? Why? | depositing/because of fractional reserve system |
| what happens when feds sell bonds? | reduces money supply, reduces reserves, lending slows, money creation reverses |
| Which tool does the fed use most often when changing money supply? why? | open-market operation/ because there is often little change in bank laws and regs. |
| Reserve Requirements | Amount of reserves banks must hold against deposits |
| An increase in reserve requirements mean | banks must hold more in reserve, less loans, lowers money multiplier |
| decrease in reserve requirements | lowers reserve ratio, increases lending amount, increases money multiplier |
| if the fed increases reserve ratio and the bank has not yet accumulated that reserve, what must happen? | banks curtail lending until reserve ratio is met |
| what is the discount rate? | interest rate on loans fed makes to banks |
| Why would a bank borrow from the Fed? | because it has too few reserves to meet it's reserve requirements |
| A higher discount rate does what to banks? | discourages borrowing, lowers money supply |
| A lower discount rate will | encourage borrowing by banks and increase money supply |
| the fed uses discount rates not only to increase money supply but also to___ | help struggling banks when they are in trouble (ie: bad loans, rumors of bank runs) |
| because fed control of money supply is not precise, what 2 problems can occur? | cannot control amount of household deposits and cannot control what banks will lend |
| In a fractional reserve system, the amount of money in the economy depends on the behavior of____and ____ | depositors and bankers |
| what problem did a bank have using the fractional reserve system? | A bank run (think: It's a Wonderful Life) |
| The Great Depression______the money creation process. How? | reversed/heavy withdrawels, lower reserves, loans stopped |
| What lessens the 'need' for a bank run? | FDIC (federal deposit insurance corp) making a bank more stable |
| If the fed wanted to use all three of its policy tools to decrease the money supply what would it do? | sell bonds, increase discount rates, and increase reserve requirements |
| how would a bank create money? | hold a fraction of their deposits in reserve and lend out the rest |
| what distinguishes money from other assets in the economy? | it is readily accepted as payment for goods/services |
| what kind of money do we use? Fiat or commodity? | Fiat |
| what are demand deposits and why should they be included in the stock of money? | balances in bank you can access with a check/because it is liquid |
| why does (in most years) the production of G/S rise? | ^labor force, ^ in capital stock and ^ in technology |
| if firms cannot sell all their G/S what happens? | cut back on production, lay off workers (unemployment rises), real GDP falls |
| falling incomes and rising unemployment is called_____if mild, _____if severe | a recession/a depression |
| depression is | severe recession |
| what model do most economists use to analyze short run fluctuations? | aggregate supply and aggregate demand |
| fluctuations in the economy is called the____ | business cycle |
| longest period in US history without a recession was | 1991-2001 |
| 3 key facts about economic fluctuations are: | they are irregular and unpredictable/ most macro qty's fluctuate together/ as output falls UE rises |
| what is used to measure short run changes in the economy? | Real GDP |
| Real GDP measures _____ and ______. | value of all G/S produced in a given time and total income (adj for inflation) of everyone in economy. |
| In recessions, ____and ____decline and ____rises | real GDP/investment spending/UE |
| declines in ______account for 2/3 of declines of GDP during recessions | investment |
| unemployment rate never falls to zero but instead fluctuates aroundits natural rate of | 5-6% |
| Classical theory describes the world in the _____ run, not in the ______run | long/short |
| The model of AS and AD focuses on two variables: | 1. economy's output of G/S measured by Real GDP and 2. Average level of prices as measured by CPI or GDP deflator |
| output is a _____variable | real |
| Price level is a______variable | nominal |
| AD Curve | qty of G/S that hhd, firms, and abroad want to buy at each price level |
| AS Curve | QTY of G/S that firms choose to produce/sell at each price level |
| on the AS/AD model what is indicated on the horizontal axis | Quantity of output |
| on the AS/AD model what is indicated on the vertical axis | Price level |
| When price level falls, the real value of the dollar ____ conversely, if the price level rises, the real value of the dollar ____ | rises/falls |
| what would cause households to invest in interest bearing accounts? | a price level fall (because now they have excess money) |
| what happens to interest rates when prices fall? | PL's falling, people investing more (driving down rates) |
| how does lower interest rates affect investment? | lower rates encourage borrowing for larger purchases |
| how does lower interest rates affect international investments? | because rates are lower, US investors may invest abroad to take advantage of higher returns |
| How does investing abroad affect US G/S | it devalues the dollar, US G/S become less expensive and net exports rise due to greater demand |
| does an increase in real value of a dollar increase or decrease net exports | decreases |
| what 3 distinct things happen when price level falls? | 1. consumers are wealthier and consume more 2. Int rates fall, borrowing increases 3. currency depreciates and net exports rise |
| what 3 things happen when price level rises? | 1. decreased wealth/less consumption 2. int rates rise/discourage investments & borrowing 3. currency appreciates with less net exports |
| Why is the slope of AD downward? | Wealth effect, int. rate effect and exchange rate effect |
| which way would the AD curve shift is people began saving more and consuming less? | left |
| Which way would the AD curve shift if people began spending more and saving less? ie: a boom | right |
| one policy variable that can shift the AD either right or left is: | taxation, raising tax shifts left, lowering tax shifts right |
| changes in monetary policy has played an important role in shifting the____curve | AD |
| Y= | C+I+G+NX (G being fixed) |
| how does int'l speculators affect AD curve if they invest in the US | dollar value rises/g/s becomes more expensive vs foreign g/s- net exports fall- AD curve shifts left |
| 4 changes that cause AD to shift | Changes in consumption, investment, net exports and government purchases |
| The AS curve is ____in long run and ____ _____in short run | vertical/upward sloping |
| Wealth effect | PL falls encourages greater consumption |
| Interest-Rate effect | PL falls, interest rate falls, encourages spending on investment |
| Exchange rate effect | PL falls, exchange rate depreciates, net exports rise |
| in long run, the economy's production of G/S (real GDP) depends on: | supply of labor, capital, nat. resources and technology to make it all work |
| if two economies were identical except one had 2x more money in circulation - that economy's price would be _____ of the other but output g/s would be _____ | double/same |
| why is the AS curve vertical in the long run? | because PL does not affect long run determinants of real GDP (qty of outputs) |
| The long run AS curve is vertical because the Qty of output or ____variable doe not depend on the PL or ____variable | real/nominal |
| The classical principle works well when studying the economy over ___ ____ but not in the____ ____ | long run/short run |
| What the economy produces with unemployment is at a normal rate | Natural Rate of Output |
| Any change in the economy that alters the Natural rate of output _____the long run AS curve | shifts |
| Any policy or event that raises real GDP makes the AS curve ___ ____ | shift right |
| Any policy or event that lowers real GDP makes the AS curve | shift left |
| the two most important forces that shift the AS and AD are | Technology (AS) and Monetary (AD) |
| Short run fluctuations should be viewed as _______ from the continuing long run trends of growth and inflation | deviations |
| long run ______ provide the background for short run ______ | trends/fluctuations |
| the key difference between the economy in the short run and the long run is the behavior of the | Aggregate Supply |
| In the short run PL does or does not affect outputs? | Does (PL rise-qty of g/s rise, PL falls-qty of g/s falls) |
| name three reasons for an upward sloping AS in the short run: | Sticky wage, sticky price, misperceptions |
| Sticky wage theory- nominal wages are based on expected prices and do not ____when prices are different than expected | respond immediately |
| sticky wages encourage firms to ____outputs when prices are ____ | decrease, lower |
| sticky price theory is slow adjustment due to _____ _____ | menu costs |
| because not all prices adjust instantly, an unexpected fall in price level can cause some firms to ____ ____ | reduce outputs |
| mathematically, upward sloping AS is | QO + NR of output + a(actual price level - expected price level) |
| long and short run AS curves shift if supplies of capital, nat. resources, labor or technology changes, what shifts only short run and not long run? | Expected price level |
| in order for AD, LR AS and SR AS to all intersect during the LR equilibrium what must be true? | actual price and expected price levels must be the same |
| 2 causes of economic fluctuations | shifts in AD and AS |
| When AD shifts left, prices rise and output falls, what are commonly called? | inflation (PL rises) and stagnation (outputs fall) |
| When stagnation and inflation occur together it is called_____ | stagflation |
| how does stagflation affect nominal wages in the short run? | because of sticky wage theory, prices will rise even higher and cause AS to shift again to left |
| higher prices leading to higher wages leading to even higher prices is called_____ | Wage price spiral |
| Shifts in AS can cause________, a combination of recession or falling output and infaltion or rising prices. | stagflation |
| Policymakers who "accomodate" the AS shift may mitigate impact but will ___ the price level ____ | increase/permanently |
| Of the 3 reasons for the downard slope of AD, which is the most important reason? | Interest-rate effect |
| Theory of Liquidity preference | Keynes- int. rate adjusts to bring money S and money D into balance |
| nominal interest rate | what it is reported to be |
| real interest rate | nominal int rate adjusted for inflation |
| how does fed policy affect the economy when they buy govt bonds | increases money supply and shifts AD right |
| How does the fed affect the economy when they sell govt bonds | it would decrease the money supply and shift the demand curve left (contract) |
| what is the federal funds rate | the int rate charged on loans from bank to bank |
| who sets the fed funds rate | FOMC |
| changes in monetary policy to expand AD can be done in 2 ways | increasing MS or lowering interest rate |
| re: fiscal policy, when the govt uses taxation does it directly or indirectly shift AD | indirectly |
| re: fiscal policy, when the govt alters it's spending, does it directly or indirectly shift AD | directly |
| marginal propensity to consume (MPC) | the fraction of income a hhd will consume than save ex: .75 out of 1.00 = MPC of 3/4 |
| The multiplier effect of govt spending causes the AD to | shift again |
| while in increase in govt spending causes an expansion of AD what effect has an opposing action | Crowding out effect - higher interest rates/lower investment |
| Suppose AD shifts left, why might the fed choose not to increase money supply? | because of lag time, situation might have corrected and increased MS will cause inflation |
