Download Econ Unit 4 Notes - Phoenix Union High School District

Economics
Unit 4 Notes and Terms
Fiscal and Monetary Policy
Economic Statistics Rules of Thumb
aka “The Economic Sweet Spot”
Good  1-3% Inflation Bad
Bad  3-4% Growth (RGDP) Good
Good  4-6% Unemployment Bad
Economic Statistics- Expansionary Policy
3% CPI Increase/ Inflation Rate
-2% Growth in RGDP
10% Unemployment Rate
What is the problem with the economy?
Recession!
How do you know this?
Unemployment is at a very high rate, higher than it’s
normal range of 3-5%. The economy is also shrinking,
since the RGDP is negative.
Economic Statistics- Expansionary Policy
3% CPI Increase/ Inflation Rate
-2% Growth in RGDP
10% Unemployment Rate
What can the Congress and the President do to solve/
help this situation?
Increase the amount of income for people! This will put
more money into the economy and get it expanding again.
1. Fiscal Policy- Using Taxes and Government Spending to
achieve specific economic goals.
2. Expansionary Fiscal Policy- Efforts by Congress and the
President to stimulate the economy and get it expanding.
Used during a recession. Tries to increase aggregate
demand.
 1. Taxes- Decrease

2. Government Spending- Increase

3. Transfer Payments- Increase
Economic Statistics Rules of Thumb
aka “The Economic Sweet Spot”
Good  1-3% Inflation Bad
Bad  3-4% Growth (RGDP) Good
Good  4-6% Unemployment Bad
Economic Statistics- Contractionary Policy
15% CPI Increase/ Inflation Rate
5% Growth in RGDP
4% Unemployment Rate
What is the problem with the economy?
Inflation!
How do you know this?
CPI is going up at a very high rate. Higher than it’s
normal range of 2-3%.
Economic Statistics- Contractionary Policy
15% CPI Increase/ Inflation Rate
5% Growth in RGDP
4% Unemployment Rate
What can the Congress and the President do to solve/
help this situation?
Decrease the amount of income for people! This will
put less money into the economy and get it to slow
down or contract.
3. Contractionary Fiscal Policy- Efforts by Congress
and the President to constrict the economy and get it
contracting. Used during an expansion with high
inflation. Tries to decrease aggregate demand. 3
“Tools” of Fiscal Policy:

1. Taxes- Increase

2. Government Spending- Decrease

3. Transfer Payments- Decrease
4. Discretionary Stabilizers- Fiscal policy tools that require
Congress and the President to take some action.

Examples- increase
or decrease taxes,
create or eliminate a
tax break, Spend more
on infrastructure,
national defense,
education, NASA,
FBI, national parks
5. Automatic Stabilizers- Fiscal policy tools that do not require
Congress and the President to take some action.

Examples- Welfare, food stamps, unemployment
compensation, section 8 housing, AHCCS, other
programs based on income
U.S. Income-Maintenance System

Entitlement Programs

Social Security

Earned-Income Tax Credit (EITC)




Medicare and Medicaid
Unemployment Compensation
Public Assistance “Welfare”
Supplemental Security Income (SSI)
Program
Temporary Assistance for Needy Families
(TANF)
Food-Stamp Program
Section 8 Housing Vouchers



6. Barter- Trading of goods and services without the use of
money.
 Not very efficient! It lacks a “coincidence of wants”.
Trueques (barter markets) of Argentina
Baseball
cards!
Pogs!
Marbles!
7. History of Money- Sources of money’s value
 Commodity Money- An item that has
value of its own is used as money
 Examples: Gold, Silver, Salt, Beaver
pelts, fishhooks, tobacco, shells

Representative Money- An item that has
value because it can be exchanged for
something valuable on its own is used as
money
 Examples: Gold and Silver certificates

Fiat Money- Govt. says it is money and
we accept it
 Examples: U.S. Coins and Currency
Yap Island
Stone Money
Rai stones
Commodity,
Representative,
or Fiat Money?
U.S. Currency
Features
8. Functions of money
1. Medium of exchange Accepted in trade for G & S

2. Store of value Can be saved for use at a later
date
8. Functions of money
3. Unit of Account/ Measure of value Easy to judge the worth of different
products

4. Standard of Deferred Payment
 Used as a standard benchmark for
specifying future payments for
current purchases, that is, buying now
and paying later.
9. Characteristics of money- Why do we use certain items as
money?

1. Divisibility Easy to break into smaller units

2. Portability Easy to carry or transport

3. Durability Lasts a long time

4. Stability in value Holds its value over time
(no inflation!)
10. M1- Measure of the supply of money in circulation.
Used by the Federal Reserve and others to measure the
growth of money in circulation. Includes the following:

1. Coins and Currency

2. Demand Deposits/
Checking Accounts/ Debit

3. Traveler’s Checks
11. M2- Another measure of the supply of money. Used for the
same reason as M1. Many economists feel it more accurately
reflects the "readily available" supply of money(the money that
can relatively quickly be turned into cash). M2 includes
everything in M1 plus the following major components :




1.
2.
3.
4.
Savings Accounts
Money Market Accounts (MMA’s)
Certificates of Deposit (CD’s)
Eurodollars (U.S. $ in Euro banks)
12. M3 = M2 + Large Time Deposits
Broadest definition of the money supply
M1
M2
Currency +
54%
M1
Checkable Deposits +
46%
20%
February 2006
Small Time Deposits +
15%
Money Market Mutual
Funds Held By Individuals +
(MMMF)
11%
Savings Deposits
Including Money Market +
Deposit Accounts (MMDA)
54%
Totals
$1,375
Billion
$6,758
Billion
13. The Federal Reserve (The Fed)- Central bank of the U.S.
Privately owned and financed by member banks in the U.S.
Very important and powerful. The Fed is given power by law to
conduct the following major functions:
1. Check clearing- Clears checks written under one bank
and then deposited in another bank.
2. Bank Regulation- Keeps banks honest and depositors'
money safe from banks misuse.
3. Providing Currency- Issues, but does not print, new
money when banks turn in old, worn out currency.
4. Regulating the money supply (using the 3 tools)Increase or decrease the money supply to fight inflation
and / or prevent the economy from entering a recession.
14. Structure of the Fed (Major parts)1. Regional Banks- 12 regional banks; AZ in the 12th
district; San Francisco HQ of 12th district; New York most
important district. Regional banks are in charge of the 1st 3
functions listed above.
Phoenix Federal Reserve Cash Processing Facility
Cash Vault: Built to
1550 N 47th Ave
withstand an airplane crash
Phoenix, AZ 85043
Armored Car Trap
Cash Processing
Robots at Federal
Reserve Facility
14. Structure of the Fed (Major parts)2. Board of Governors- 7 members, appointed to 14 year terms
by the President and confirmed by the Senate. Oversee all
operations of the Fed.
Janet Yellen, current chairman
of the Fed (1st woman!)
Benjamin Bernanke, previous
chairman of the Fed
Fed Salary Facts




Fed Chairman Makes $199,700
All other members make $179,700.
Salaries are not very high when
compared to what a private banker
could make
These numbers are as of November,
2015.
14. Structure of the Fed (Major parts)3. Federal Open Market Committee (FOMC)- 12 members (7
BofG's and 5 district bank presidents) Decides monetary
policy (see below).
7 members, appointed by
president, confirmed by
the Senate
12 regional bank presidents
All 7 of B of G
serve on FOMC
5 of the branch
presidents serve on
the FOMC too, 1 of
5 is always from NY
branch
Framework of the Federal Reserve
System and the Relationship to the Public
Board of Governors
Federal Open Market Committee
12 Federal Reserve Banks
Commercial Banks
Thrift Institutions
(Savings and Loan Associations,
Mutual Savings Banks,
Credit Unions)
The Public
(Households and
Businesses)
GLOBAL PERSPECTIVE
Central Banks, Selected Nations
Australia:
Canada:
Euro Zone:
Japan:
Mexico:
Russia
Sweden:
United Kingdom:
United States:
Reserve Bank of Australia (RBA)
Bank of Canada
Central Bank of Europe (CBE)
Bank of Japan (BOJ)
Banco de Mexico (Mex Bank)
Central Bank of Russia
Sveriges Riksbank
Bank of England
Federal Reserve System (the “Fed”)
(12 Regional Federal Reserve Banks)
15. Monetary Policy- The control of the supply of money by the
Fed to achieve specific economic goals. Changing the
money supply will cause the aggregate demand curve
to shift!
16. The Three(3) Tools of Monetary Policy 1. Open Market Operations (OMO)- Sets the
Federal Funds Rate = IR Banks charge Banks

Buying and Selling Government Bonds (Securities)
 Fed Buys bonds Decrease in Fed Funds Rate
Increase in $ supply
 Fed Sells bonds Increase in Fed Funds Rate 
Decrease in $ supply
 Buy Bigger, Sell Smaller
Tools of Monetary Policy
Fed Buys $1,000 Bond from the Public
Check is Deposited
New Reserves
$1000
$800
Excess
Reserves
$4000
Bank System Lending
$200
Required
Reserves
$1000
Initial
Checkable
Deposit
Total Increase in the Money Supply, ($5000)
2. Discount Rate (DR)- IR Fed charges Banks
Fed decreases DR Banks borrow more $
Banks lend out more $ Increase in $ Supply
Fed increases DR Banks borrow less $
Banks lend out less $ decrease in $ Supply
Many days, there is less than $100 million in discountwindow loans outstanding. That leapt to almost $46
billion after the Sept. 11, 2001, terrorist attacks on the
U.S. disrupted the money markets.
Link to change in FFR and DR rates
3.
Reserve Requirements (RR)-
Fed decreases RR Banks Lend out more $
Increase in $ Supply
Fed increases RR Banks Lend out less $
Decrease in $ Supply
Link to use of technology to reduce required
reserves
Economic Statistics Rules of Thumb
aka “The Economic Sweet Spot”
Good  1-3% Inflation Bad
Bad  3-4% Growth (RGDP) Good
Good  4-6% Unemployment Bad
Economic Statistics- Expansionary Policy
3% CPI Increase/ Inflation Rate
-2% Growth in RGDP
10% Unemployment Rate
What is the problem with the economy?
Recession!
How do you know this?
Unemployment is at a very high rate, higher than it’s
normal range of 4-6%. The economy is also shrinking,
since the RGDP is negative.
Economic Statistics- Expansionary Policy
3% Inflation
-2% Growth (RGDP)
10% Unemployment
What can the Federal Reserve do to solve/ help this
situation?
Increase the money supply! This will put more money
into the economy and get it expanding again.
17. Expansionary Monetary Policy (Easy money) Efforts by the Fed to stimulate the economy and get it
expanding. Used during a recession. Tries to increase
aggregate demand.

1. Open Market Operations (OMO) Fed Buys bonds/ Decreases Fed Funds Rate

2. Discount Rate (DR) Fed decreases DR

3.

Reserve Requirements (RR)Fed decreases RR
Expansionary Monetary Policy
CAUSE-EFFECT CHAIN
Problem: Unemployment and Recession
Fed Buys Bonds, Lowers Reserve
Ratio, or Lowers the Discount Rate
Excess Reserves Increase
Federal Funds Rate Falls
Money Supply Rises
Interest Rate Falls
Investment Spending Increases
Aggregate Demand Increases
Real GDP Rises
Economic Statistics- Contractionary Policy
15% CPI Increase/ Inflation Rate
5% Growth in RGDP
4% Unemployment Rate
What is the problem with the economy?
Inflation!
How do you know this?
CPI is going up at a very high rate. Higher than it’s
normal range of 1-3%.
Economic Statistics- Contractionary Policy
15% CPI Increase/ Inflation Rate
5% Growth in RGDP
4% Unemployment Rate
What can the Federal Reserve do to solve/ help this
situation?
Decrease the money supply! This will put less money
into the economy and get it to slow down or contract.
18. Contractionary Monetary Policy (Tight money) - Efforts
by the Fed to constrict the economy and slow it down. Used
during an expansion with high inflation. Tries to decrease
aggregate demand.

1. Open Market Operations (OMO)
Fed Sells bonds/ Increases Fed Funds Rate

2. Discount Rate (DR) Fed increases DR

3.

Reserve Requirements (RR)Fed increases RR
Restrictive Monetary Policy
CAUSE-EFFECT CHAIN
Problem: Inflation
Fed Sells Bonds, Increases Reserve
Ratio, or Increases the Discount Rate
Excess Reserves Decrease
Federal Funds Rate Rises
Money Supply Falls
Interest Rate Rises
Investment Spending Decreases
Aggregate Demand Decreases
Inflation Declines
19. Prime rate- The interest rate that the biggest banks charge
their biggest and best customers. When the Fed increases
Discount and/ or Federal Funds rate banks raise their Prime rate
which causes other rates(car, home loans, etc.) to increase. If
the Fed decreases its rates banks do the same with their prime
and other rates.
Fed ↑ Money Supply Banks borrow more  Banks lend/ create
more  ↓ Prime rate  ↓ rates for homes, cars, education  ↑ C,
I  ↑ AD.
20. Budget Deficit- When government spending exceeds
government revenue. When the government spends more than it
makes. To make up the deficit the government is forced to
borrow money. A yearly total. $433 billion for 2015.
Budget Deficit vs. Budget Surplus
A deficit exists when Government Spending is > Tax Revenue.
So: G > T
A surplus exists when Government Spending is < Tax Revenue.
So: G < T
A balanced budget exists when:
Government Spending = Tax Revenue.
So: G = T
21. National Debt- The sum of all past budget
deficits. Currently $18.6 trillion (November,
2015).
Who do we owe the debt to?
As of February 2012, China ($1.18 trillion), Japan ($1.09
trillion), and Brazil ($225.5 billion) are the biggest foreign
holders of our debt.
22. Discretionary Spending- Spending that is not required by law.
Examples: ∆Taxes/ Tax deductions, Defense, NASA , Education,
law enforcement, etc.
23. Entitlement Spending- Spending programs required by
law to be paid to anyone who meets criteria set by law.
Examples: S.S, Welfare, Stud. Loans, Food Stamps
This then puts a squeeze on discretionary spending such as
defense, NASA, national parks, law enforcement, education, etc.
24. Transfer payments- Payments made to individuals/
households by the government.
Examples: S.S, Welfare, Stud. Loans, Food Stamps
Balanced Budget
There are good economic reasons (crowding out)
for a balanced budget.
A balanced budget exists when:
Government Spending is = Tax Revenue.
So: G = T
Balanced Budget
A deficit exists when Government Spending is > Tax Revenue.
So: G > T
So, to have a balanced budget the government
must:
↓ G or
↑ T or
↓ Transfer
payments
12. The Monetary Equation of Exchange
MxV = P x Q
Money X Velocity = Price Level X Quantity
M = M1
Velocity = The number of times a dollar is spent
Price Level = The rate of inflation (GDP Price Deflator)
Quantity = Real GDP
Real GDP (Q) x Price Level (P) = Nominal GDP
13. Money Multiplier = 1/ Reserve Requirement X Initial Deposit
Example:
If the Fed has a Reserve Requirement of 20% this means 1 ÷ .2 = 5
5 is the money multiplier
$1000 initial deposit  $800 (80%) in excess reserves and $200 (20%) in
required reserves
$1000 x 5 = $5000 of money in circulation
$800 x 5 = $4000 new money created by the banking SYSTEM (not by 1 bank)
$1000 initial deposit + $4000 new money = $5000 in circulation
Refer to Money Creation Simulation for more examples
Bank
(1)
Acquired
Reserves
and Deposits
Bank A
$100.00
Bank B
80.00
Bank C
64.00
Bank D
51.20
Bank E
40.96
Bank F
32.77
Bank G
26.21
Bank H
20.97
Bank I
16.78
Bank J
13.42
Bank K
10.74
Bank L
8.59
Bank M
6.87
Bank N
5.50
Other Banks 21.99
(2)
Required
Reserves
(Reserve
Ratio = .2)
(3)
Excess
Reserves
(1)-(2)
$20.00
16.00
12.80
10.24
8.19
6.55
5.24
4.20
3.36
2.68
2.15
1.72
1.37
1.10
4.40
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
(4)
Amount Bank Can
Lend; New Money
Created = (3)
$80.00
64.00
51.20
40.96
32.77
26.21
20.97
16.78
13.42
10.74
8.59
6.87
5.50
4.40
17.59
$400.00
Monetary Multiplier or Checkable-Deposit
Multiplier
Monetary
Multiplier
=
or in Symbols…
Graphic
Example
1
Required Reserve Ratio
1
m =
New Reserves
$100
$80
Excess
Reserves
$400
Bank System Lending
Money Created
R
$20
Required
Reserves
$100
Initial
Deposit
The Monetary Multiplier

W 13.2
Reversibility
 Making Loans Creates Money
 Loan Repayment Destroys Money
 Multiple Step Money Expansion
 Multiple Step Destruction of Money
26. Crowding Out Effect- The rise in interest rates caused by
increased borrowing by the federal government.
↑ Interest rates  ↓ C, I  ↓ AD  ↓ GDP  Contractionary impact
DO NOT Draw the graph!
27. Crowding In effect- The decrease in interest rates caused by
decreased borrowing by the federal government.
↓ Interest rates  ↑ C, I  ↑ AD  ↑ GDP  Expansionary impact
DO NOT Draw the graph!
How the Fed’s
actions affect
all of the
participants in
the economy
Federal Deficits and Surpluses – 1990 - 2005
as a Percentage of Potential GDP
(1)
Year
(2)
Actual
Deficit (-) or
Surplus (+)
(3)
Standardized
Deficit (-) or
Surplus (+)
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
-3.9%
-4.4%
-4.5%
-3.8%
-2.9%
-2.2%
-1.4%
-0.3%
+0.8%
+1.4%
+2.5%
+1.3%
-1.5%
-3.4%
-3.5%
-2.6%
-2.2%
-2.5%
-2.9%
-2.9%
-2.1%
-2.0%
-1.2%
-1.0%
-0.4%
+0.1%
+1.1%
+1.1%
-1.1%
-2.7%
-2.4%
-1.8%
Source: Congressional Budget Office
The Global Greenback

U.S. Currency Circulating Abroad






Russians $40 Billion
Argentineans $7 Billion
Polish $6 Billion
U.S. Profits from Dollars Leaving
Black Markets and Illegal Activities
Seeking Stable Purchasing Power



Soviet Union Collapse
Brazil Inflation Issues
Asian Market Exchanges
Bank Panics of 1930-1933









Series of Bank Panics
Before Deposit Insurance
Mass Withdrawals From Fear
Move to Cash Reduced Money Supply Through
Reduction in Loans
Multiple Contraction Slowed Lending and the
Economy
1933 National Bank Holiday for One Week
Resulted in FDIC and 25% Drop in Money Supply
Contributed to the Great Depression
Regulation Protects the System Today