Term
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Definition
Three basic functions:
1. functions as a medium of exchange or means of payment
2. Functions as a unit of account because prices for all goods and services are expressed in units of money; dollars, yen, .... This allows us to determine how much of any good we are foregoing when consuming another.
3. Functions as a store of value because I can work for money now, save it, and use the value of my labor later. Money preserves value better when inflation is low. |
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Term
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Definition
M1: Includes all currency not held at banks, travelers' checks, and checking account deposits of individual and firms (but not govt checking accounts).
M2: includes all the components of M1, plus time deposits, savings deposits, and money market mutual fund balances. |
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Term
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Definition
Operates as intermediaries between savers and borrowers. Savers make deposits in banks to keep their money safe but also to earn a return. Banks take the deposits and put a proportion of those deposits to work by buying short-term securities such as Treasury Bills, by investing in longer-term securities such as treasury and corp bonds. The bank then lends out its funds minus the reserve requirement to borrowers. Thus the bank makes money on deposits from earning yields from securities and interest rates from consumer borrowers. A reserve requirement is required of all banks to meet the withdrawals of those savers. |
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Term
| Thrifts and thrift Institutions |
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Definition
| Refer to savings banks, credit unions, and savings and loan association (S&Ls). An S&L offers both checking and savings accounts and makes loans of various types using customer deposits. |
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Term
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Definition
| Technically an investment company. Money market is usually used to refer to debt securities with maturities of one year or less. A money market mutual fund manages the pooled funds of many investors , investing it in short-term debt securities to preserve the fund's values and earn returns for the investors. Investors have ready access to their dunds, but some funds restrict liquidity by imposing minimum check amounts or a maximum number of withdrawals each month. Offering less liquidity keeps expenses down and consequently increases returns. |
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Term
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Definition
Three primary types of Depository institutions: 1) commercial banks; 2) Thrifts and thrifts institutions; 3) Money Market Mutual Fund.
Depository institutions have four main economic functions:
1. They create Liquidity.
2. Act as financial intermediaries, to lower cost of funds for borrowers. compared to cost of finding funds yourself.
3. Monitor risk of loans. Institutions can higher far more people and hence make better risk adjustments.
4. Pool the default risks of individual loans by holding a portfolio of loans. |
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Term
| Four primary regulations for Banks' Balance Sheets. |
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Definition
Four primary areas:
1. A minimum amount of equity (owner's) capital must be maintained to give owners strong incentives to manage th risk of their asset portfolio.
2. Reserve requirements set a minimum percentage of deposits that must be retained by the institution, either in cash or as deposits with the Federal Reserve.
3. There are restrictions on the types of deposits that various institutions may accept.
4. Rules about the proportions of various types of loans that the institutions can make. ex) a restriction on the proportion of commercial loans they can hold. |
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Term
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Definition
An entity in the Government to manage the money supply in such a way as to keep inflation low and at the same time, promote economic growth and full employment. Additionally, the fed attempts to reduce the magnitude of the expansions and recessions that make up business cycles.
Three Policy Tools of the Fed are:
1. Discount Rate
2. Bank Reserve Requiment
3. Open market operations. |
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Term
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Definition
One of the three policy tools of the Fed used to manage money supply and create stabilization within the markets
Discount rate: is the rate at which banks can borrow reserves from the Fed. A lower rate makes reserves less costly to banks, encourages lending, and tends to decrease interest rates. |
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Term
| Bank Reserve Requirements |
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Definition
Percentage of deposits that banks must retain (not loan out). By increasing the percentage of deposits banks are required to retain as reserves, the Fed effectively decreases the funds that are available for lending.
This amount available tends to increase interest rates.
*This tool only works well if banks are willing to lend, and customers are willing to borrow.* |
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Term
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Definition
Buying or selling of Treasury securities by the Fed in the open market. When the Fed buys securities, cash replaces securities in investor accounts, banks have excess reserves, more funds are available for lending, and interest rates decrease. This increase Money Supply.
The selling of securities has the same effect.
**The most commonly used tool and is important in achieving the federal funds target rate.** |
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Term
| Assets of Federal Reserve |
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Definition
Three assets of the Fed:
1) Gold, deposits with other central banks, and special drawing rights at the International monetary Fund.
2) U.S. treasury bills, notes, and bonds
**Government securities are 90% of the Fed's Balance Sheet.**
3) Loans to Banks (reserves loaned at the discount rate).
The great majority (over 90%) of the liabilities of the Fed are Federal Reserve Notes. That is, U.S. currency in circulation. Bank Reserve deposits are a small part of the Fed's liabilities |
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Term
| Fractional Reserve System |
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Definition
| Such as the Fed system. A bank is only required to hold a fraction of its deposits in reserve. |
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Term
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Definition
| Used to measure the reserve requirement. Deposits in excess of the required reserve (excess reserves) may be loaned. |
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Term
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Definition
The effect and process of lending, spending, and depositing until the amount of excess reserves available for lending is zero.
EQ = (1/rr)*x
Example: say you deposit $1,000 with a reserve requirement of 15%. So the bank holds $150 as a requirement, and lends out the other $850. Then the other lending institution holds onto 15% of $850, to lend out $722.50... and so on. What is the multiplier effect?
answer: (1/15%)*$1,000 = $6,666.67 |
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Term
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Definition
Includes the Fed Reserve Notes, coins (issued by the U.S. Treasury), and banks' reserve deposits at the Fed.
Fed uses open market operations to expand the Monetary base. |
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Term
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Definition
| The effect of people holding part of the increase in the money supply as currency, rather than depositing it so that it can be used to create more loans. |
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Term
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Definition
For a change in monetary base, you must take into account the required reserve ratio and the currency drain.
Eq: (1+c)
(r+c)
r=reserve requirement
c= currency as a percentage of deposits.
Can be stated as:
change (chg) in quantity of money = chg. in monetary base x money multiplier |
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Term
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Definition
| Largely determined by interest rates. High interest rates, people will save and deposit to earn that interest. Demand for money is low cause there is less incentive to spend money. |
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Term
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Definition
| Supply of Money is determined by the central bank (the Fed in the US) and is independent of the interest rate. This accounts for the vertical (perfectly inelastic) supply curve. |
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Term
| What are the sources of investment in an economy? |
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Definition
National Savings
Borrowing from abroad
Government Savings |
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Term
| What idea does the Laffer curve illustrate? |
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Definition
| The Laffer curve illustrates the idea that at some tax rate, the disincentive to work from higher tax rates outweighs the revenue-raising effects of higher tax rates, so that total tax revenue will actually fall in response to a further increase in the tax rate |
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Term
True/False
Does government budget surpluses increase total investment funds |
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Definition
True
Government budget deficits decrase the quantity of savings, which increases the real interest rate, leading fimrs to reduce invesment in physical capital. |
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Term
| What is the crowding-out effect? |
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Definition
| Government budget deficits decrase the quantity of savings, which increases the real interest rate, leading fimrs to reduce invesment in physical capital. THis is known as the crowding-out effect |
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Term
| What affect does increased taxes on capital income have on the long-run growth rate of real GDP? |
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Definition
| Increased taxes on capital income make saving less attractive which DECREASES investment and the long-run growth rate of real GDP |
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Term
| What affects does an increase in taxes (whether imposed on income or on expenditures) on the incentive to work? |
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Definition
| An increase in taxes (whether imposed on income or on expenditures) REDUCES the incentive to work, which decreases the quantity of labor supplied and thereby reduces potential GDP from the supply side |
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Term
| What are the generational effects of fiscal policy on taxes necessary to pay for federal programs? |
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Definition
| Generational effects of fiscal policy refer to the effects of POSTPONING the taxes necessary to pay for currently federal programs, shifting the burden of paying for unfunded programs to a future generation of taxpayers. |
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Term
| What are the measures of the government expenditure multiplier and tax multiplier? |
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Definition
| THe government expenditure multiplier and tax multiplier are measures of the magnified effects of change in govenment spending and changes in taxes on aggregate demand. |
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Term
| What are discretionary fiscal policy changes intended to do to the economic cycles? |
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Definition
| Discretionary fiscal policy changes intended to SMOOTH economic cycles but are difficult to time correctly because of a recognition lag, while the government identifies the appropriate policy change; law-making lag, during which fiscal policy changes are enacted; and an impact lag, the time it takes for policy changes to take effect and influence the economic activity |
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Term
| What are automatic fiscal stablizers which reduce timing problems? |
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Definition
| INDUCED TAXES AND NEEDS-TESTED SPENDING are automatic fiscal stablizers which reduce timing problems because they tend to increase spending and reduce taxes (increase the deficit) during recessions and decrease spending and increase taxes (reduce the deficit) during economic expansions |
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Term
| What is a Recognition Delay |
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Definition
| Discretionary fiscal policy decisions are made by the President and voted on by Congress. The state of the economy is complex and it may take the Administration time to recognize the extent of the economic problems |
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Term
| What is Administrative or law-making delay? |
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Definition
| THe Administation and Congress cannot vote and enact decisions overnight. Legal changes are delayed while elected officials debate the issues |
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Term
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Definition
| Time passes before the effects of the fiscal policy changes are felt. Delays occur in implementing increases and decreases in govenment spending and taxing. It takes time for corporations and individuals to act on the fiscal policy changes. |
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Term
What are Automatic Stabilizers? |
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Definition
| Automatic Stabilizers are built in fiscal devices triggered by the state of the economy. They minimize timing problems encountered by discretionary fiscal policy stabilizers. |
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Term
| What is the Ricardo Barro Effect? |
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Definition
| The Ricardo Barro efect refers to the fact that increases in the current deficit means greater taxes in the future. |
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Term
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Definition
| Fiscal policy refers to the federal government's use of spending and taxation to meet the macroeconomic goals. |
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Term
| When is the federal budget said to be Balanced? |
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Definition
| The federal budget is said to be balanced when tax revenues equal federal government expenditures |
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Term
| What is the difference between the federal budget surplus and deficit? |
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Definition
| The budget surplus occurs when government tax revenues exceed expenditures and a budget deficit occurs when government expenditures exceed tax revenues |
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Term
| Explain the supply-side effects that influence the fiscal policy. |
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Definition
Supply-side effects refer to the influence that fiscal policy, especially taxation, has on long-run aggregrate supply (potential real GDP)
Income taxes reduces the incentive to work by creating a TAX WEDGE between pretax and after-tax wages.
Increase in income taxes casues after-tax wages to fall.
As income taxes rise, the full-employment supply of labor fall---reduces potential GDP |
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Term
True/False
Will an increase in the tax rate result in a increase in tax revenue? |
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Definition
False
Because of the supply-side effect on potential GDP, an increase in tax rates will not always result in an increase in tax revenue.
Beyond a certain point, the increase in taxes per dollar earned will be more than offset by the decrease in the total number of dollars earned.----LAFFER CURVE |
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Term
| What are the major components of GDP? |
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Definition
Total investments
Consumption
Government Spending
Net Exports |
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Term
| What are the sources of financing for investments? |
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Definition
1. National savings
2. Borrowing from foreigners
3. Government Savings |
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Term
| What does govenment savings refer to? |
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Definition
Government Savings equals the difference between govenment tax revenues and expenditures
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Term
True/False
Do investments directly affects the growth rate in real GDP? |
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Definition
True
Investment directly affects the growth reat in real GDP. |
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Term
| What are two fiscal policy decisions? |
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Definition
1. Government taxing
2. Spending decisions |
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Term
| What is automatic fiscal policy? |
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Definition
| Automatic fiscal policy refers to government spending changes tha toccur when economic growht slows or accelaerates, but do not require action by policy makers |
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Term
True/False
The tax multiplier is greater than the government expenditure multiplier |
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Definition
FALSE
The government expenditure multiplier is greater than the tax multiplier |
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Term
| The Laffer Curve shows that an increase in the tax rate |
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Definition
| Can either increase or decrease total tax revenue |
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