ECON 2301 FINAL - Assignment Essays

question

45 degree line

answer

a reference line used to show the relationship of consumption = disposable income

question

Relationship between income/consumption and income/savings

answer

A direct (positive) relationship

question

Aggregate demand-aggregate supply model
(AD-AS model)

answer

A flexible-price model that enables analysis of simultaneous changes of real GDP and the price level

question

Aggregate demand curve

answer

Shows the level of real output that the economy demands at each price level

question

Aggregate demand downsloping

answer

Caused by the real-balances effect, the interest-rate effect, and the foreign purchases effect

question

Real-balances effect

answer

Indicates that inflation reduces the real value or purchasing power of fixed-value financial assets held by households, causing cutbacks in consumer spending

question

Interest-rate effect

answer

Means that with a specific supply of money, a higher price level increases the demand for money, thereby raising the interest rate and reducing investment purchaces

question

Foreign purchases effect

answer

Suggests that an increase in one country's price level relative to the price levels in other countries reduces the net export component of that nation's aggregate demand

question

Determinants of aggregate demand

answer

Consist of spending by domestic consumers, by business, government, and foreign buyers

question

Changes in aggregate demand involve two components

answer

1.) A change in one of the determinants of aggregate demand that directly changes the amount of real GDP demanded
2.) A multiplier effect that produces a greater ultimate change in aggregate demand than the initiating change in spending

question

Factors that shift the aggregate demand curve

answer

1.) Change in consumer spending
2.) Change in investment spending
3.) Change in government spending
4.) Change in net export spending

question

Changes in consumer spending consist of

answer

1.) Consumer wealth
2.) Consumer expectations
3.) Household borrowing
4.) Taxes

question

Changes in investment spending consist of

answer

1.) Interest rates
2.) Expected returns

question

Expected returns

answer

1.) Expected future business conditions
2.) Technology
3.) Degree of excess capacity
4.) Business taxes

question

Changes in net export spending consists of

answer

1.) National income abroad
2.) Exchange rates

question

What determines the extent of the shift of the aggregate demand curve?

answer

The size of the initial change in spending and the strength of the economy's mulitplier

question

Aggregate supply

answer

A schedule or curve showing the relationship between a nation's price level and the amount of real domestic output that firms in the economy produce

question

Aggregate supply curve

answer

Shows the levels of real output that business will produce at various possible price levels

question

The slope of the aggregate supply curve depends upon...

answer

The flexibility of input and output prices

question

Aggregate supply curves are categorized into three horizons

answer

1.) Immediate-short-run aggregate supply curve
2.) Short-run aggregate supply curve
3.) Long-run aggregate supply curve

question

Immediate-short-run aggregate supply curve

answer

Assumes that both input prices and output prices are fixed. It's a horizontal line at the current price level.

question

Short-run aggregate supply curve

answer

Assumes nominal wages and other input prices remain fixed while output prices vary. It's generally upsloping because prices firms myst receive rise as real output expands.

question

Long-run aggregate supply curve

answer

Assumes that nominal wages and other input prices fully match any change in the price level. The curve is vertical at the full-employment output level.

question

Why does the short-run aggregate supply curve serve as the core aggregate supply curve for analyzing the business cycle and economic policy?

answer

It's the only version of aggregate supply that can handle simultaneous changes in the price level and real output

question

Unless specified, all references to "aggregate supply" refer to...

answer

The short-run aggregate supply or the short-run aggregate supply curve

question

Per-unit production cost =

answer

total input cost / units of output

question

Determinants of aggregate supply

answer

1.) Input prices
2.) Productivity
3.) Legal-institutional environment

question

A change in any determinant of aggregate supply will change...

answer

Per-unit production costs at each level of output and therefore will shift the aggregate supply curve

question

Input prices

answer

A major ingredient of per-unit production costs and therefore a key determinant of aggregate supply. Can be either domestic or imported.

question

Imported Resource Prices

answer

1.) A decrease in the price of imported resources increases U.S. aggregate supply
2.) An increase in their price reduces U.S. aggregate supply

question

Domestic Resource Prices

answer

1.) Increases/decreases in wages affect per-unit production costs
2.) The aggregate supply curve shifts when the prices of land and capital inputs change

question

Productivity

answer

A measure of the relationship between a nation's level of real output and the amount of resources used to produce that output.
A measure of average real output or of real output per unit of input.

question

Productivity =

answer

total output / total inputs

question

An increase in productivity...

answer

1.) Enables the economy to obtain more real output from its limited resources
2.) Affects aggregate supply by reducing the per-unit cost of output

question

Legal-Institution Environment (two types of changes)

answer

1.) Changes in taxes and subsidies
2.) Changes in the extent of regulation

question

Higher business taxes

answer

Increase per-unit costs and reduce short-run aggregate supply. Shifts aggregate supply to the left.

question

A business subsidy

answer

A payment or tax break by government to producers. Lowers production costs and increases short-run aggregate supply. Shifts aggregate supply curve to the right.

question

More government regulation

answer

Causes an increase in per-unit production costs and shifts the aggregate supply curve to the left.

question

Intersection of the aggregate demand and aggregate supply curves

answer

Determines an economy's equilibrium price level and real GDP

question

Equilibrium price level

answer

The price level at which the aggregate demand curve intersects the aggregate supply curve

question

Equilibrium real output

answer

The real output at which the aggregate demand curve intersects the aggregate supply curve

question

At the intersection of the aggregate demand and aggregate supply curves...

answer

The quantity of real GDP demanded = the quantity of real GDP supplied

question

Increases in aggregate demand to the right of the full-employment output

answer

Cause inflation and positive GDP gaps (actual GDP exceeds potential GDP)

question

An upsloping aggregate supply curve does what to the multiplier effect?

answer

Weakens it because a portion of the increase in aggregate demand is dissipated in inflation

question

Decreases in the aggregate demand to the left of the full-employment output

answer

Cause recession, negative GDP gaps, and cyclical unemployment

question

Why may the price level not fall during recessions?

answer

Because of the downward inflexible prices and wages

question

Causes of inflexible prices

answer

1.) fear of price wars
2.) menu costs
3.) wage contracts
4.) efficiency wages
5.) minimum wages

question

What happens when the price level is fixed?

answer

Changes in aggregate demand produce full-strength multiplier effects

question

Leftward shift of the aggregate supply curve

answer

Reflect increase in per-unit production costs and cause cost-push inflation, with accompanying negative GDP gaps

question

Rightward shifts of the aggregate supply curve

answer

Caused by large improvements in productivity, help explain the simultaneous achievement of full employment, economic growth, and price stability

question

The recession of 2001

answer

Ended the expansionary phase of the business cycle

question

Council of Economic Advisers (CEA)

answer

A group of 3 economists appointed by the president to provide expertise and assistance on economic matters

question

Expansionary fiscal policy

answer

Policy that consists of government spending increases, tax reductions, or both, designed to increase aggregate demand and therefore raise real GDP

question

3 options government uses to stimulate the economy

answer

1.) increase government spending
2.) reduce taxes
3.) use some combination of the two

question

Budget deficit

answer

Government spending in excess of tax revenues

question

Contractionary fiscal policy

answer

Policy that consists of government spending reductions, tax increases, or both, designed to decrease aggregate demand and therefore lower/eliminate inflation

question

Budget surplus

answer

Tax revenues in excess of government spending

question

Economists who believe there are many unmet social and infrastructure needs

answer

Usually recommend that government spending be increased during recessions and during inflation, recommend tax increases

question

Economists who think that the government is too large and inefficien

answer

Usually recommend tax cuts during recessions and cuts in government spending during times of inflation

question

Built-in stabilizer

answer

Anything that increases the governments budget deficit (or reduces its budget surplus) during a recession and increases its budget surplus (or reduces its budget deficit) during an expansion without requiring explicit action by policymakers

question

During recession...

answer

The federal budget automatically moves toward a stabilizing deficit

question

During expansion...

answer

The federal budget automatically moves toward and anti-inflationary surplus

question

Built-in stability

answer

Lessens, but does not fully correct, undesired changes in real GDP

question

Cyclical deficit

answer

A federal budget deficit that is caused by a recession and the consequent decline in tax revenues

question

Cyclically adjusted budget

answer

Measures what the federal budget deficit or surplus would have been under existing tax rates and government spending levels if the economy had achieved its full-employment level of GDP

question

Changes in the cyclical-budget deficit or surplus

answer

Provide meaningful information as to whether the government's fiscal policy is expansionary, neutral, or contractionary

question

Changes in the actual budget deficit or surplus

answer

Do not provide meaningful information since such deficits and surpluses can include cyclical deficits or surpluses

question

Progressive tax system

answer

The average tax rate rises with GDP

question

Proportional tax system

answer

The average tax rate remains constant as GDP rises

question

Regressive tax system

answer

The average tax rate falls as GDP rises

question

Average tax rate =

answer

tax revenue / GDP

question

What did the Bush administration and Congress chose to do in 2001?

answer

They chose to reduce marginal tax rates and phase out the federal estate tax

question

2001 recession

answer

1.) federal spending for the war on terrorism sky rocketed
2.) federal budget = $128 billion
3.) Deficit of $158 billion in 2002

question

What did the Bush administration and Congress do in 2003 to counteract the recession?

answer

Accelerated the tax reductions scheduled under the 2001 tax law and cut tax rates on capital gains and dividends to stimulate the sluggish economy

question

What were the results in 2007?

answer

The economy had reached its full employment level of output

question

What type of fiscal policy did the U.S. government begin to implement after the recession of 2007-2009?

answer

A highly expansionary fiscal policy

question

Problems that complicate the enactment and implementation of fiscal policy

answer

1.) recognition lag
2.) administrative lag
3.) operational lag

question

Recognition lag

answer

The time between the beginning of recession or inflation and the certain awareness that it is actually happening. Arrises because the economy does not move smoothly through the business cycle.

question

Administrative lag

answer

The time between the need for fiscal action is recognized and the action is taken

question

Operational lag

answer

Occurs between the time fiscal action is taken and the time that action affects output, employment, or price level

question

Political business cycle

answer

Fluctuations in the economy caused by the alleged tendency of Congress to destabilize the economy by reducing taxes and increasing government expenditures after elections

question

Crowding-out effect

answer

An expansionary fiscal policy (deficit spending) may increase the interest rate and reduce investment spending, thereby weakening or canceling the stimulus of the expansionary policy

question

Public debt

answer

The total accumulation of all past federal government deficits and surpluses and consists of Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds

question

U.S. government securities

answer

Financial instruments issued by the federal government to borrow money to finance expenditures that exceed tax revenues

question

External public debt

answer

The portion of the public debt owed to foreign citizens, firms, and institutions

question

What can be used as money?

answer

Anything that is accepted as
1.) a medium of exchange
2.) a unit of monetary account
3.) a store of value

question

Medium of exchange

answer

Any item sellers generally accept and buyers generally use to pay for a good or service; a convenient means of exchanging goods and services without engaging in barter

question

Unit of account

answer

A standard unit in which prices can be stated and the value of goods and services can be compared, one of the three functions of money

question

Store of value

answer

An asset set aside for future use; one of the three functions of money

question

Liquidity

answer

The ease with which an asset can be converted quickly into cash with little or no loss of purchasing power

question

Two major definitions of the money supply

answer

1.) M1
2.) M2

question

answer

Consists of currency and checkable deposits

question

answer

Consists of M1 plus savings deposits

question

What do savings deposits include (when referring to M2)?

answer

Includes money market deposit accounts, small-denominated time deposits, and money market mutual fund balances held by individuals

question

What does money represent?

answer

The debts of government and institutions offering checkable deposits (commercial banks and thrift institutions)

question

Why does money have value?

answer

Because of the goods, services, and resources it will command in the market

question

What is depended upon to maintain the purchasing power of money?

answer

The government's effectiveness in managing the money supply

question

The U.S. banking system consists of

answer

1.) the Board of Governors of the Federal Reserve System
2.) the 12 Federal Reserve Banks
3.) About 6000 commercial banks and 8500 thrift institutions

question

The Board of Directors (Federal Reserve Banks)

answer

The basic policymaking body for the entire banking system

question

12 Federal Reserve Banks

answer

Make the directives of the Board and the Federal Open Market Committee effective

question

Types of Federal Reserve Banks

answer

1.) quasi-public banks
2.) central banks
3.) bankers' banks

question

Major functions of the Fed

answer

1.) issue currency
2.) set reserve requirements and holding reserves
3.) lend money to financial institutions and serve as the lender of last resort in national financial emergencies
4.) provide for check collection
5.) acts as the fiscal agent
6.) supervising banks
7.) controlling the money supply

question

What is the Fed?

answer

It's an independent institution, controlled neither by the president of the United States nor by Congress

question

What does the Fed's independence shield them from?

answer

Political pressure and allows it to raise and lower interest rates as needed to promote full employment, price stability, and economic growth

question

Central Bank

answer

The 12 Federal Reserve Banks accommodate the geographic size and economic diversity of the United States

question

Quasi-Public Banks

answer

Banks that blend private ownership and public control

question

Bankers' Banks

answer

Perform the same functions for banks and thrifts as those institutions perform for the public

question

Term Auction Facility

answer

Used by the Fed to auction off loans to banks and thrifts

question

Subprime mortgage loans

answer

High-interest-rate loans given to home buyers with higher-than-average credit risk

question

Mortgage-backed securities

answer

Bonds back by mortgage payments

question

Securitization

answer

The process of slicing up and bundling groups of loans, mortgages, corporate bonds, or other financial debts into distinct new securities

question

Factors of the financial crisis of 2007-2008

answer

1.) unprecedented rise in mortgage loan defaults
2.) near-collapse of several major financial institutions
3.) generalized freezing up of credit availability

question

What caused the financial crisis (2007-2008)?

answer

1.) bad mortgage loans together with declining real estate prices
2.) underestimation of risk by holders of mortgage-backed securities and faulty insurance securities designed to protect holders of mortgage-backed securities from risk of default

question

What did Congress pass in 2008?

answer

Troubled Asset Relief Program (TARP)

question

Troubled Asset Relief Program (TARP)

answer

Authorized the U.S. Treasury to spend up to $700 billion to make emergency loans and guarantees to failing financial firms

question

What aided the Treasury rescue/bailout?

answer

The lender-of-last-resort loans provided by the Federal Reserves to financial institutions through a series of newly established Fed facilities

question

What intensifies the moral hazard problem?

answer

The TARP loans and the Fed's lender-of-last-resort actions

question

Moral hazard problem

answer

The tendency of financial investors and financial firms to take on greater risk when they assume they are at least partially insured against loss

question

Main categories of the U.S. financial services industry

answer

1.) commercial banks
2.) thrifts
3.) insurance companies
4.) mutual fund companies
5.) pension funds
6.) securities firms
7.) investment banks

question

What did Congress pass in 2010 in response to the financial crisis?

answer

Wall Street Reform and Consumer Financial Protection Act

question

Commercial banks

answer

State and national banks that provide checking and savings accounts, sell certificates of deposit, and make loans

question

Thrifts

answer

Savings and loan associations, mutual saving banks, and credit unions that offer checking and savings accounts and make loans

question

Insurance companies

answer

Firms that offer policies through which individuals pay premiums to insure against some loss, say, disability, or death

question

Mutual fund companies

answer

Firms that pool deposits by customers to purchase stocks or bonds

question

Pension funds

answer

For-profit or non-profit institutions that collect savings from workers throughout their working years and then buy stocks and bonds with the proceeds and make monthly retirement payments

question

Securities firms

answer

Firms that offer security advice and buy and sell stocks and bonds for clients

question

Investment banks

answer

Firms that help corporations and governments raise money by selling stocks and bonds

question

Why is the U.S. banking system called a "fractional reserve" system?

answer

Only a fraction of checkable deposits are backed by reserves of currency in bank vaults or deposits at the central bank

question

How can the operation of a commercial bank be understood?

answer

Through its balance sheet

question

Balance sheet

answer

A statement of assets and claims on those assets

question

Assets =

answer

Liabilities + net worth

question

How individual banks create money through balance sheets (steps)

answer

1.) creating a bank
2.) acquiring property and equipment
3.) accepting deposits
4.) depositing reserves in a federal reserve bank
5.) clearing a check drawn against the Bank
--------------------------------------------------------
6.) granting a loan
7.) buying government securities

question

Required reserves

answer

An amount of funds equal to a specified percentage of the bank's own deposit liabilites

question

Reserve ratio

answer

The ratio of the required reserves the commercial bank must keep to the bank's own outstanding checkable-deposit liabilities

question

Reserve ratio (equation)

answer

Reserve ratio = commercial bank's required reserves / commercial bank's checkable-deposit liabilities

question

How to find excess reserves

answer

1.) bank's checkable-deposit liabilities * reserve ratio = required reserves
2.) actual reserves - required reserves

question

Granting a loan and buying government securities explain what?

answer

1.) how a commercial bank can literally create money by making loans
2.) how banks create money by purchasing government bonds from the public

question

Commercial banking system as a whole can lend....

answer

By a multiple of its excess reserves because the system as a whole cannot lose reserves

question

Individual banks can lose...

answer

Reserves to other banks in the system

question

Monetary multiplier

answer

Defines the relationship between any new excess reserves in the banking system and the magnified creation of new checkable-deposit money by banks as a group

question

Monetary multiplier =

answer

1 / required reserve ratio

question

Maximum checkable-deposit creations =

answer

excess reserves * monetary multiplier

question

The multiple credit expansion process (is reversible/is not reversible).

answer

Is reversible

1 of 143

question

45 degree line

answer

a reference line used to show the relationship of consumption = disposable income

question

Relationship between income/consumption and income/savings

answer

A direct (positive) relationship

question

Aggregate demand-aggregate supply model
(AD-AS model)

answer

A flexible-price model that enables analysis of simultaneous changes of real GDP and the price level

question

Aggregate demand curve

answer

Shows the level of real output that the economy demands at each price level

question

Aggregate demand downsloping

answer

Caused by the real-balances effect, the interest-rate effect, and the foreign purchases effect

question

Real-balances effect

answer

Indicates that inflation reduces the real value or purchasing power of fixed-value financial assets held by households, causing cutbacks in consumer spending

question

Interest-rate effect

answer

Means that with a specific supply of money, a higher price level increases the demand for money, thereby raising the interest rate and reducing investment purchaces

question

Foreign purchases effect

answer

Suggests that an increase in one country's price level relative to the price levels in other countries reduces the net export component of that nation's aggregate demand

question

Determinants of aggregate demand

answer

Consist of spending by domestic consumers, by business, government, and foreign buyers

question

Changes in aggregate demand involve two components

answer

question

Factors that shift the aggregate demand curve

answer

1.) Change in consumer spending
2.) Change in investment spending
3.) Change in government spending
4.) Change in net export spending

question

Changes in consumer spending consist of

answer

1.) Consumer wealth
2.) Consumer expectations
3.) Household borrowing
4.) Taxes

question

Changes in investment spending consist of

answer

1.) Interest rates
2.) Expected returns

question

Expected returns

answer

1.) Expected future business conditions
2.) Technology
3.) Degree of excess capacity
4.) Business taxes

question

Changes in net export spending consists of

answer

1.) National income abroad
2.) Exchange rates

question

What determines the extent of the shift of the aggregate demand curve?

answer

The size of the initial change in spending and the strength of the economy's mulitplier

question

Aggregate supply

answer

A schedule or curve showing the relationship between a nation's price level and the amount of real domestic output that firms in the economy produce

question

Aggregate supply curve

answer

Shows the levels of real output that business will produce at various possible price levels

question

The slope of the aggregate supply curve depends upon...

answer

The flexibility of input and output prices

question

Aggregate supply curves are categorized into three horizons

answer

1.) Immediate-short-run aggregate supply curve
2.) Short-run aggregate supply curve
3.) Long-run aggregate supply curve

question

Immediate-short-run aggregate supply curve

answer

Assumes that both input prices and output prices are fixed. It's a horizontal line at the current price level.

question

Short-run aggregate supply curve

answer

Assumes nominal wages and other input prices remain fixed while output prices vary. It's generally upsloping because prices firms myst receive rise as real output expands.

question

Long-run aggregate supply curve

answer

Assumes that nominal wages and other input prices fully match any change in the price level. The curve is vertical at the full-employment output level.

question

Why does the short-run aggregate supply curve serve as the core aggregate supply curve for analyzing the business cycle and economic policy?

answer

It's the only version of aggregate supply that can handle simultaneous changes in the price level and real output

question

Unless specified, all references to "aggregate supply" refer to...

answer

The short-run aggregate supply or the short-run aggregate supply curve

question

Per-unit production cost =

answer

total input cost / units of output

question

Determinants of aggregate supply

answer

1.) Input prices
2.) Productivity
3.) Legal-institutional environment

question

A change in any determinant of aggregate supply will change...

answer

Per-unit production costs at each level of output and therefore will shift the aggregate supply curve

question

Input prices

answer

A major ingredient of per-unit production costs and therefore a key determinant of aggregate supply. Can be either domestic or imported.

question

Imported Resource Prices

answer

1.) A decrease in the price of imported resources increases U.S. aggregate supply
2.) An increase in their price reduces U.S. aggregate supply

question

Domestic Resource Prices

answer

1.) Increases/decreases in wages affect per-unit production costs
2.) The aggregate supply curve shifts when the prices of land and capital inputs change

question

Productivity

answer

A measure of the relationship between a nation's level of real output and the amount of resources used to produce that output.
A measure of average real output or of real output per unit of input.

question

Productivity =

answer

total output / total inputs

question

An increase in productivity...

answer

1.) Enables the economy to obtain more real output from its limited resources
2.) Affects aggregate supply by reducing the per-unit cost of output

question

Legal-Institution Environment (two types of changes)

answer

1.) Changes in taxes and subsidies
2.) Changes in the extent of regulation

question

Higher business taxes

answer

Increase per-unit costs and reduce short-run aggregate supply. Shifts aggregate supply to the left.

question

A business subsidy

answer

A payment or tax break by government to producers. Lowers production costs and increases short-run aggregate supply. Shifts aggregate supply curve to the right.

question

More government regulation

answer

Causes an increase in per-unit production costs and shifts the aggregate supply curve to the left.

question

Intersection of the aggregate demand and aggregate supply curves

answer

Determines an economy's equilibrium price level and real GDP

question

Equilibrium price level

answer

The price level at which the aggregate demand curve intersects the aggregate supply curve

question

Equilibrium real output

answer

The real output at which the aggregate demand curve intersects the aggregate supply curve

question

At the intersection of the aggregate demand and aggregate supply curves...

answer

The quantity of real GDP demanded = the quantity of real GDP supplied

question

Increases in aggregate demand to the right of the full-employment output

answer

Cause inflation and positive GDP gaps (actual GDP exceeds potential GDP)

question

An upsloping aggregate supply curve does what to the multiplier effect?

answer

Weakens it because a portion of the increase in aggregate demand is dissipated in inflation

question

Decreases in the aggregate demand to the left of the full-employment output

answer

Cause recession, negative GDP gaps, and cyclical unemployment

question

Why may the price level not fall during recessions?

answer

Because of the downward inflexible prices and wages

question

Causes of inflexible prices

answer

1.) fear of price wars
2.) menu costs
3.) wage contracts
4.) efficiency wages
5.) minimum wages

question

What happens when the price level is fixed?

answer

Changes in aggregate demand produce full-strength multiplier effects

question

Leftward shift of the aggregate supply curve

answer

Reflect increase in per-unit production costs and cause cost-push inflation, with accompanying negative GDP gaps

question

Rightward shifts of the aggregate supply curve

answer

Caused by large improvements in productivity, help explain the simultaneous achievement of full employment, economic growth, and price stability

question

The recession of 2001

answer

Ended the expansionary phase of the business cycle

question

Council of Economic Advisers (CEA)

answer

A group of 3 economists appointed by the president to provide expertise and assistance on economic matters

question

Expansionary fiscal policy

answer

Policy that consists of government spending increases, tax reductions, or both, designed to increase aggregate demand and therefore raise real GDP

question

3 options government uses to stimulate the economy

answer

1.) increase government spending
2.) reduce taxes
3.) use some combination of the two

question

Budget deficit

answer

Government spending in excess of tax revenues

question

Contractionary fiscal policy

answer

Policy that consists of government spending reductions, tax increases, or both, designed to decrease aggregate demand and therefore lower/eliminate inflation

question

Budget surplus

answer

Tax revenues in excess of government spending

question

Economists who believe there are many unmet social and infrastructure needs

answer

Usually recommend that government spending be increased during recessions and during inflation, recommend tax increases

question

Economists who think that the government is too large and inefficien

answer

Usually recommend tax cuts during recessions and cuts in government spending during times of inflation

question

Built-in stabilizer

answer

question

During recession...

answer

The federal budget automatically moves toward a stabilizing deficit

question

During expansion...

answer

The federal budget automatically moves toward and anti-inflationary surplus

question

Built-in stability

answer

Lessens, but does not fully correct, undesired changes in real GDP

question

Cyclical deficit

answer

A federal budget deficit that is caused by a recession and the consequent decline in tax revenues

question

Cyclically adjusted budget

answer

Measures what the federal budget deficit or surplus would have been under existing tax rates and government spending levels if the economy had achieved its full-employment level of GDP

question

Changes in the cyclical-budget deficit or surplus

answer

Provide meaningful information as to whether the government's fiscal policy is expansionary, neutral, or contractionary

question

Changes in the actual budget deficit or surplus

answer

Do not provide meaningful information since such deficits and surpluses can include cyclical deficits or surpluses

question

Progressive tax system

answer

The average tax rate rises with GDP

question

Proportional tax system

answer

The average tax rate remains constant as GDP rises

question

Regressive tax system

answer

The average tax rate falls as GDP rises

question

Average tax rate =

answer

tax revenue / GDP

question

What did the Bush administration and Congress chose to do in 2001?

answer

They chose to reduce marginal tax rates and phase out the federal estate tax

question

2001 recession

answer

1.) federal spending for the war on terrorism sky rocketed
2.) federal budget = $128 billion
3.) Deficit of $158 billion in 2002

question

What did the Bush administration and Congress do in 2003 to counteract the recession?

answer

Accelerated the tax reductions scheduled under the 2001 tax law and cut tax rates on capital gains and dividends to stimulate the sluggish economy

question

What were the results in 2007?

answer

The economy had reached its full employment level of output

question

What type of fiscal policy did the U.S. government begin to implement after the recession of 2007-2009?

answer

A highly expansionary fiscal policy

question

Problems that complicate the enactment and implementation of fiscal policy

answer

1.) recognition lag
2.) administrative lag
3.) operational lag

question

Recognition lag

answer

The time between the beginning of recession or inflation and the certain awareness that it is actually happening. Arrises because the economy does not move smoothly through the business cycle.

question

Administrative lag

answer

The time between the need for fiscal action is recognized and the action is taken

question

Operational lag

answer

Occurs between the time fiscal action is taken and the time that action affects output, employment, or price level

question

Political business cycle

answer

Fluctuations in the economy caused by the alleged tendency of Congress to destabilize the economy by reducing taxes and increasing government expenditures after elections

question

Crowding-out effect

answer

An expansionary fiscal policy (deficit spending) may increase the interest rate and reduce investment spending, thereby weakening or canceling the stimulus of the expansionary policy

question

Public debt

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The total accumulation of all past federal government deficits and surpluses and consists of Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds

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U.S. government securities

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Financial instruments issued by the federal government to borrow money to finance expenditures that exceed tax revenues

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External public debt

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The portion of the public debt owed to foreign citizens, firms, and institutions

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What can be used as money?

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Anything that is accepted as
1.) a medium of exchange
2.) a unit of monetary account
3.) a store of value

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Medium of exchange

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Any item sellers generally accept and buyers generally use to pay for a good or service; a convenient means of exchanging goods and services without engaging in barter

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Unit of account

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A standard unit in which prices can be stated and the value of goods and services can be compared, one of the three functions of money

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Store of value

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An asset set aside for future use; one of the three functions of money

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Liquidity

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The ease with which an asset can be converted quickly into cash with little or no loss of purchasing power

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Two major definitions of the money supply

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1.) M1
2.) M2

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Consists of currency and checkable deposits

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Consists of M1 plus savings deposits

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What do savings deposits include (when referring to M2)?

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Includes money market deposit accounts, small-denominated time deposits, and money market mutual fund balances held by individuals

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What does money represent?

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The debts of government and institutions offering checkable deposits (commercial banks and thrift institutions)

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Why does money have value?

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Because of the goods, services, and resources it will command in the market

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What is depended upon to maintain the purchasing power of money?

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The government's effectiveness in managing the money supply

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The U.S. banking system consists of

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1.) the Board of Governors of the Federal Reserve System
2.) the 12 Federal Reserve Banks
3.) About 6000 commercial banks and 8500 thrift institutions

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The Board of Directors (Federal Reserve Banks)

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The basic policymaking body for the entire banking system

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12 Federal Reserve Banks

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Make the directives of the Board and the Federal Open Market Committee effective

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Types of Federal Reserve Banks

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1.) quasi-public banks
2.) central banks
3.) bankers' banks

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Major functions of the Fed

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What is the Fed?

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It's an independent institution, controlled neither by the president of the United States nor by Congress

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What does the Fed's independence shield them from?

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Political pressure and allows it to raise and lower interest rates as needed to promote full employment, price stability, and economic growth

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Central Bank

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The 12 Federal Reserve Banks accommodate the geographic size and economic diversity of the United States

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Quasi-Public Banks

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Banks that blend private ownership and public control

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Bankers' Banks

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Perform the same functions for banks and thrifts as those institutions perform for the public

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Term Auction Facility

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Used by the Fed to auction off loans to banks and thrifts

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Subprime mortgage loans

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High-interest-rate loans given to home buyers with higher-than-average credit risk

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Mortgage-backed securities

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Bonds back by mortgage payments

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Securitization

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The process of slicing up and bundling groups of loans, mortgages, corporate bonds, or other financial debts into distinct new securities

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Factors of the financial crisis of 2007-2008

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1.) unprecedented rise in mortgage loan defaults
2.) near-collapse of several major financial institutions
3.) generalized freezing up of credit availability

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What caused the financial crisis (2007-2008)?

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What did Congress pass in 2008?

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Troubled Asset Relief Program (TARP)

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Troubled Asset Relief Program (TARP)

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Authorized the U.S. Treasury to spend up to $700 billion to make emergency loans and guarantees to failing financial firms

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What aided the Treasury rescue/bailout?

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The lender-of-last-resort loans provided by the Federal Reserves to financial institutions through a series of newly established Fed facilities

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What intensifies the moral hazard problem?

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The TARP loans and the Fed's lender-of-last-resort actions

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Moral hazard problem

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The tendency of financial investors and financial firms to take on greater risk when they assume they are at least partially insured against loss

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Main categories of the U.S. financial services industry

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1.) commercial banks
2.) thrifts
3.) insurance companies
4.) mutual fund companies
5.) pension funds
6.) securities firms
7.) investment banks

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What did Congress pass in 2010 in response to the financial crisis?

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Wall Street Reform and Consumer Financial Protection Act

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Commercial banks

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State and national banks that provide checking and savings accounts, sell certificates of deposit, and make loans

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Thrifts

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Savings and loan associations, mutual saving banks, and credit unions that offer checking and savings accounts and make loans

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Insurance companies

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Firms that offer policies through which individuals pay premiums to insure against some loss, say, disability, or death

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Mutual fund companies

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Firms that pool deposits by customers to purchase stocks or bonds

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Pension funds

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For-profit or non-profit institutions that collect savings from workers throughout their working years and then buy stocks and bonds with the proceeds and make monthly retirement payments

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Securities firms

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Firms that offer security advice and buy and sell stocks and bonds for clients

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Investment banks

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Firms that help corporations and governments raise money by selling stocks and bonds

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Why is the U.S. banking system called a "fractional reserve" system?

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Only a fraction of checkable deposits are backed by reserves of currency in bank vaults or deposits at the central bank

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How can the operation of a commercial bank be understood?

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Through its balance sheet

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Balance sheet

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A statement of assets and claims on those assets

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Assets =

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Liabilities + net worth

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How individual banks create money through balance sheets (steps)

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Required reserves

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An amount of funds equal to a specified percentage of the bank's own deposit liabilites

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Reserve ratio

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The ratio of the required reserves the commercial bank must keep to the bank's own outstanding checkable-deposit liabilities

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Reserve ratio (equation)

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Reserve ratio = commercial bank's required reserves / commercial bank's checkable-deposit liabilities

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How to find excess reserves

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1.) bank's checkable-deposit liabilities * reserve ratio = required reserves
2.) actual reserves - required reserves

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Granting a loan and buying government securities explain what?

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1.) how a commercial bank can literally create money by making loans
2.) how banks create money by purchasing government bonds from the public

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Commercial banking system as a whole can lend....

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By a multiple of its excess reserves because the system as a whole cannot lose reserves

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Individual banks can lose...

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Reserves to other banks in the system

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Monetary multiplier

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Defines the relationship between any new excess reserves in the banking system and the magnified creation of new checkable-deposit money by banks as a group

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Monetary multiplier =

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1 / required reserve ratio

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Maximum checkable-deposit creations =

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excess reserves * monetary multiplier

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The multiple credit expansion process (is reversible/is not reversible).

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Is reversible

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