Macroeconomics Test Review
Chapters 14-18 

Controlling Total Economic Activity
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14. Fiscal Policy

15. Monetary Policy

16. Stagflation and the Rise of Supply-Side Economics

17. Budget Deficits

18. Economic Growth

14. Fiscal Polic Review View Entire Chapter 14).
    A. Economic goals of the United States
         1. Employment Act of 1946 was a reaction to a five-year economic growth plan of the Soviet Union.
             a. Set four economic goals
1. Economic growth   2. Price stability     3. Low unemployment     4. Positive balance of payments
            b. Created the President's Council of Economic Advisor
        2. Humphrey-Hawkins Act of 1978 was a reaction to stagflation of the 1970's and it set five-year goals for economy.
            a. 4% unemployment     b. 3% inflation by 1985, 0% by 1988     c. Reduce balance of payments deficit  
            d. Increase economic growth and investment      e. Reduce the size of the public sector
        3. Government methods of affecting the economy to achieve economic goals
            a. Fiscal policy, the focal point of Keynesian economics, will be explored in this chapter.
            b. Monetary Policy will be covered in chapter 15.
B. Discretionary fiscal policy
         1. Discretionary fiscal policy is the deliberate manipulation of government taxing and spending to control AD and the business cycle.
         2. AD = C + I + G + XN
         3. Expansionary fiscal policy consists of reversing an economic downturn by increasing AD with deficit spending.
             a. Lower taxes to increase Consumption (C) and Investment (I)
                 1. Personal income taxes  
                 2. Capital gains taxes paid on the profit from the sale of commercial real estate, a company, and financial assets (stocks and bonds)
                 3 Investment tax creditis a direct lowering of the tax liability of companies investing in certain approved types of plant and equipment 
             b. Increase government spending (G)
             c. The result will be a fiscal stimulus through deficit spending. 
             d. The impact of a fiscal stimulus, once implemented, will affect AD.
         4. Contractionary fiscal policy: Decreasing inflationary pressure by decreasing AD
             a. Increase taxes

             b. Decrease government spending
             c. The result will be a fiscal drag with smaller deficits or a surplus. 
         5. The multiplier effect described in chapter 12 applies to fiscal policy measures.
    C. Automatic stabilizers
         1. Cause the economy to expand without government action during recession by increasing AD.
         2. Cause the economy to contract without government action during inflation by lowering AD.    
         3. Examples
             a. Transfer payments (unemployment compensation, food stamps, and other social programs) increase during recession to increase AD.
             b. Progressive taxes (income tax) increase during inflation to lower AD.
    D. Fiscal policy effectiveness is questionable 
         1. Timing
             a. Determining when recessions begin is difficult. 
                 1. Disagreement over whether the U.S. was in a recession from 1989-1991 resulted in little fiscal action being taken.
                 2. The 2001 slowdown happened so fast there was not time for preemptive action.
             b. Fiscal policy takes time to implement 
             c. There will be a delay because it takes business time to expand capital investment.                 
         2. Political considerations
             a. Some spending programs are difficult to cut (social security).
             b. Expansionary bias: people vote to spend but not to tax.
             c. Political business cycle: it is difficult to accomplish anything economically constructive during an election year 
         3. Until recently, many felt the federal debt is too big and has rendered fiscal policy ineffective. Its success in ending
             the 2001 recession has yet to be determined although the Federal budget surplus certainly makes it easier to increase 
             federal spending and decrease taxes although the expense of fighting three wars has again increased the deficit.
     E. Monetary affects of fiscal policy
         1. Until recently, government borrowing increased the demand for loanable funds causing higher long-term interest rates. 
             a. Crowding out is the term used to describe how high rates due to government borrowing lower private investment.
             b. Many feel high economic growth of the late 1990's resulted because of low interest rates caused by federal fiscal responsibility.   
         2. Now, people are concerned about the fiscal drag caused by a federal surplus.

15. Monetary Policy  View Entire Chapter 15   
     A. The Demand for Money is  Dm= Dt + D
1. Transaction Dt results because people hold money, often in a money market account, to use as a medium of exchange.
          2. Asset Demand, Dresults because people accumulate money, often held in an investment account, to buy assets.    
     B. Monetary policy is the regulation of the money supply to affect interest rates, economic activity, with the objective of noninflationary full employment.
         1. It is part of, but not the focal point of Keynesian economics.
      2.Affecting interest rates and to change investment thus  affecting economic activity is one goal of the Fed.
             a. Controlling reserve requirement may affect the money supply which may 
affect interest rates
         1. Reserve requirement is the amount of demand deposits that must be kept in cash with the Federal Reserve or in the bank.
                 2. Often expressed as a percent called the reserve ratio.
                 3. Excess reserve can be loaned as demand deposits.
                 4. Excess reserves determine the potential money supply (M1).   
Changes interest rates change investment causing a change in AD which changes economic activity.
1) Increasing the money supply may lower interest rates. increasing investment which increases AD which causes an increase in Real GDP.
2) Decreasing  the money supply may increase interest rates lowering investment which increses AD which causes an increase in Real GDP.
              c. Dollar values on this page are representative of amounts prevalent during the late 1990's (billions of dollars).
. Types of monetary policy
           1. Quantitative controls affect the money supply.
               a. Required Reserve Ratio
                   1. Lowering the reserve ratio creates excess reserves which banks may loan as newly created money. This is expansionary.
                   2. Raising the reserve ratio eliminates excess reserve so banks can not renew loans removing money and causing a contraction.
               b. Open-market operations
                   1. Buying and selling of U.S. government bonds by the Fed from banks or in the open market to change excess reserves affecting M1 supply and interest rates is
                       the primary tool.
                   2. Buying bonds is expansionary.
                       a) When buying from banks, the Federal Reserve pays with reserves providing excess reserves banks can loan as demand deposits.
                       b) When buying in the open market, increased demand from the Federal Reserve pushes up prices sellers receive, lowering the effective interest sellers pay.
                   3. Selling bonds contracts the economy.
                   4. Review of
Valuing bonds
                       a) Suppose you buy a twenty year, $10,000 bond paying 5% per year at face value of $10,000. Face value is called par value.
                           1) A few years go by and you need money and one choice is to sell the bond.
                           2) If interest rates on this type bond have gone down, people will be very anxious to buy, demand, will be high pushing price up and your will receive more than $10,000.
                           3) If rate shave gone down, no one will give you $10,000, demand will be low, so if you need the money, you will sell for less, below par.
                           4) You can hold for twenty years and get par and get the money some where else.
                      b) Therefore, interest rates and bond values (prices) go in the opposite direction, if interest rates down, old bond price up because they are at the old higher rate.
                      c) This is called the interest rate risk for bonds. Other risks have to do with issuer default and monetary inflation.
         5. It is the most powerful of the four tools.
              C. Discount rate
                   1. This is the rate charged by the Federal Reserve for loans to member banks.  
                   2. It strongly affects the prime interest rate paid by a bank's best customers.
                       a) Lower the rate to expand economy as interest rates decrease.
                       b) Raise the rate to contract economy as interest rates increase.
                       c) Another important interest rate is the federal funds rate which is the rate at which banks loan funds to each other. 
              D. Term Auction Facility
                  1. Initiated in 2007, it allows banks to add to their reserves at low rates.
                   2. Done to increase bank liquidity which was low because of a loss in reserve caused by a housing crisis.
      2. Other controls affect the actions of market participants.
              A. Moral suasion or jawboning is social pressure by influential people to encourage specific people to act in the public interest.
B. Margin requirements, the down payment required on stocks which is now 50%, is seldom changed.
              C. Consumer credit controls, on items such as credit cards, work so well it is seldom used.
D. The Federal Funds Rate is the overnight rate banks with excess fed reserve charge each banks short of fed reserve to keep the system in balance.
Most controllable interest rate   2. Targeted by monetary policy   3. Controlling reserves, controls this rate. 4. Allows some control over short-term rates.        
     D. Effectiveness of monetary policy
          1. Strengths a. Speedy, flexible  b. Somewhat isolated from political pressure  c. Hard money, restrictive policy by the Federal Reserve, has worked well recently. 
          2. Weaknesses a. Easy money has not worked well because low business profit expectations , fears over employment loss by workers make low interest rates ineffective.
              b. Bank deregulation has made commercial banks a less important supplier of investment funds thus diminishing the effectiveness of monetary policy.
              c. Changes in the velocity of money may negate some of the effects of monetary policy.


16 Stagflation and the Rise of Supply-Side Economics  View Entire Chapter 16

17. Budget Deficits  View Entire Chapter 17

18. Economic Growth  View Entire Chapter 17