Dr. Smith Harvey Economics Discussion
chyann01
unit_9_econ_ppt.pptxWELCOME TO SEMINAR 9 March 4, Wed. 10-11 pm ET
MT445-01
MANAGERIAL ECONOMICS
INSTRUCTOR: PAUL CHOI, PH.D.
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LIVE SEMINARS (Wednesday 10-11 PM ET)
Live Seminar Schedule:
• Live Seminar 1: January 7 (Wednesday 10-11 pm ET)
• Live Seminar 2: January 14 (Wednesday 10-11 pm ET)
• Live Seminar 3: January 21 (Wednesday 10-11 pm ET)
• Live Seminar 4: January 28 (Wednesday 10-11 pm ET)
• Live Seminar 5: February 4 (Wednesday 10-11 pm ET)
• Live Seminar 6: February 11 (Wednesday 10-11 pm ET)
• Live Seminar 7: February 18 (Wednesday 10-11 pm ET)
• Live Seminar 8: February 25 (Wednesday 10-11 pm ET)
• Live Seminar 9: March 4 (Wednesday 10-11 pm ET)
• Live Seminar 10: March 11 (Wednesday 10-11 pm ET)
• It is strongly suggested that you attend the graded seminar at the regularly scheduled time. If you are unable to attend the seminar, you can complete the following assignment.
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UNIT 9 READING
Chapter 25 discusses money and its four functions; how money is measured in the United States today; how banks create money; the federal reserve system; and the quantity theory of money.
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UNIT 9 READING
Chapter 26 discusses monetary policy; the money market and the Fed’s choice of monetary policy targets; the aggregate demand and aggregate supply graphs to show monetary policy on real GDP and the price level; and the Fed’s response to the financial crisis.
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UNIT 9 READING
Chapter 27 discusses fiscal policy, the effects of fiscal policy on real GDP and the price level; government purchases and tax multipliers; the limits of using fiscal policy to stabilize the economy; deficits, surpluses, and federal government debt, and the effects on fiscal policy in the long-run.
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
Money: Assets that people are generally willing to accept in exchange for goods and services or for payment of debts.
Asset: Anything of value owned by a person or a firm.
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
Barter and the Invention of Money
Commodity Money: A good used as money that also has value independent of its use as money
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
The Functions of Money
Anything used as money – whether a deerskin, a cowrie seashell, cigarettes, or a dollar bill – should fulfill the following four functions: Medium of exchange; Unit of account; Store of value; and Standard of deferred payment
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
The Functions of Money
Medium of Exchange: Money serves as a medium of exchange when sellers are willing to accept it in exchange for goods or services.
Unit of Account: In a barter system, each good has many prices.
Store of Value: Money allows value to be stored easily: If you do not use all your accumulated dollars to buy goods and services today, you can hold the rest to use in the future.
Standard of Deferred Payment: Money is useful because it can serve as a standard of deferred payment in borrowing and lending.
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
What Can Serve as Money?
Five criteria make a good suitable to use as a medium of exchange:
1 The good must be acceptable to (that is, usable by) most people.
2 It should be of standardized quality so that any two units are identical.
3 It should be durable so that value is not lost by spoilage.
4 It should be valuable relative to its weight so that amounts large enough to be useful in trade can be easily transported.
5 The medium of exchange should be divisible because different goods are valued differently.
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
What Can Serve as Money?
Commodity Money:
Commodity money meets the criteria for a medium of exchange.
Fiat Money:
It can be inefficient for an economy to rely on only gold or other precious metals for its money supply.
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READING: CHAPTER 25
What Is Money and Why Do Wee Need It?
What Can Serve as Money?
Federal Reserve System:
Central bank of the United States.
Fiat Money:
Money, such as paper currency, that is authorized by a central bank or governmental body and that does not have to be exchanged by the central bank for gold or some other commodity money.
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READING: CHAPTER 25
How Is Money Measured in the United States Today?
M1: The Narrowest Definition of the Money Supply
M1:
The narrowest definition of the money supply: The sum of currency in circulation, checking account deposits in banks, and holdings of traveler’s checks.
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READING: CHAPTER 25
How Is Money Measured in the United States Today?
M1: The Narrowest Definition of the Money Supply
M1 includes:
1 Currency, which is all the paper money and coins that are in circulation, where “in circulation” means not held by banks or the government
2 The value of all checking account deposits at banks
3 The value of traveler’s checks (although this last category is so small—less than $7 billion in May 2008- we will ignore it in our discussion of the money supply)
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READING: CHAPTER 25
How Is Money Measured in the United States Today?
M2: A Broader Definition of Money
M2:
A broader definition of the money supply: M1 plus savings account balances, small-denomination time deposits, balances in money market deposit accounts in banks, and noninstitutional money market fund shares.
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READING: CHAPTER 25
How Is Money Measured in the United States Today?
M2: A Broader Definition of Money
There are two key points about the money supply in mind:
1. The money supply consists of both currency and checking account deposits.
2. Because balances in checking account deposits are included in the money supply, banks play an important role in the process by which the money supply increases and decreases. We will discuss this second point further in the next section.
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READING: CHAPTER 25
How Is Money Measured in the United States Today?
M2: A Broader Definition of Money
What about Credit Cards and Debit Cards?
Many people buy goods and services with credit cards, yet credit cards are not included in definitions of the money supply.
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READING: CHAPTER 25
How Do Banks Create Money?
Bank Balance Sheets
Reserves: Deposits that a bank keeps as cash in its vault or on deposits with the Federal Reserve
Required Reserves: Reserves that a bank is legally required to hold, based on its checking account deposits
Required Reserve Ratio: The minimum fraction of deposits banks are required by law to keep as reserves
Excess Reserves: Reserves that banks hold over and above the legal requirement.
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READING: CHAPTER 25
How Do Banks Create Money?
The Simple Deposit Multiplier
Simple Deposit Multiplier: The ratio of the amount of deposits created by banks to the amount of new reserves.
Simple Deposit Multiplier = 1/RR
Change in checking account deposits = Change in bank reserves x 1/RR
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READING: CHAPTER 25
How Do Banks Create Money?
The Simple Deposit Multiplier versus the Real-World Deposit Multiplier
We can summarize these important conclusions:
1. Whenever banks gain reserves, they make new loans, and the money supply expands.
2. Whenever banks lose reserves, they reduce their loans, and the money supply contracts.
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READING: CHAPTER 25
The Federal Reserve System
Fractional reserve banking system: A banking system in which banks keep less than 100 percent of deposits as reserves.
Bank run: A situation in which many depositors simultaneously decide to withdraw money from a bank.
Bank panic: A situation in which many banks experience runs at the same time.
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READING: CHAPTER 25
The Federal Reserve System
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READING: CHAPTER 25
How the Federal Reserve Manages the Money Supply
Monetary Policy: The actions the Federal Reserve takes to manage the money supply and interest rates to pursue economic objectives.
To manage the money supply, the Fed uses three monetary policy tools:
1. Open market operations
2. Discount policy
3. Reserve requirements
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READING: CHAPTER 25
How the Federal Reserve Manages the Money Supply
Open Market Operations
Federal Open Market Committee (FOMC): The Federal Reserve committee responsible for open market operations and managing the money supply in the United States
Open Market Operations: The buying and selling of Treasury securities by the Federal Reserve in order to control the money supply.
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READING: CHAPTER 25
How the Federal Reserve Manages the Money Supply
Discount Policy
Discount Loans: Loans the Federal Reserve Makes to Banks
Discount Rate: The interest rate the Federal Reserve charges on discount loans
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READING: CHAPTER 25
How the Federal Reserve Manages the Money Supply
Reserve Requirements
Reserve Requirements: When the Fed reduces reserve ratio, it converts required reserves into excess reserves.
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READING: CHAPTER 25
The Federal Reserve System
Putting It All Together: Decisions of the Nonbank Public, Banks, and the Fed
Using Its Three Tools – open market operations, the discount rate, and reserve requirements – the Fed has substantial influence over the money supply, but that influence is not absolute.
Two other actors – the nonbank public and banks – also influence the money supply.
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READING: CHAPTER 25
The Quantity Theory of Money
Connecting Money and Prices: The Quantity Equation
In the early twentieth century, Irving Fisher, an economist at Yale, formalized the connection between money and prices using the quantity equation:
MV = PY
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READING: CHAPTER 25
The Quantity Theory of Money
Connecting Money and Prices: The Quantity Equation
Velocity of Money: The average number of times each dollar in the money supply is used to purchase goods and services included in GDP.
V = PY/M
Quantity Theory of Money: A theory of the connection between money and prices that assumes that the velocity of money is constant.
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READING: CHAPTER 25
The Quantity Theory of Money
The Quantity Theory Explanation of Inflation
We can transform the quantity equation from:
MV = PY
to:
Growth rate of the money supply + Growth rate of velocity = Growth rate of the price level (or inflation rate) + Growth rate of real output
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READING: CHAPTER 25
The Quantity Theory of Money
The Quantity Theory Explanation of Inflation
The growth rate of the price level is just the inflation rate, so we can rewrite the quantity equation to help us understand the factors that determine inflation:
Inflation rate = Growth rate of the money supply + Growth rate of velocity − Growth rate of real output
If Irving Fisher was correct that velocity is constant, then the growth rate of velocity will be zero. This allows us to rewrite the equation one last time:
Inflation rate = Growth rate of the money supply − Growth rate of real output
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READING: CHAPTER 25
The Quantity Theory of Money
The Quantity Theory Explanation of Inflation
This equation leads to the following predictions:
1 If the money supply grows at a faster rate than real GDP, there will be inflation.
2 If the money supply grows at a slower rate than real GDP, there will be deflation. (Recall that deflation is a decline in the price level.)
3 If the money supply grows at the same rate as real GDP, the price level will be stable, and there will be neither inflation nor deflation.
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READING: CHAPTER 25
The Quantity Theory of Money
High Rates of Inflation
Very high rates of inflation—in excess of hundreds or thousands of percentage points per year—are known as hyperinflation.
Economies suffering from high inflation usually also suffer from very slow growth, if not severe recession.
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READING: CHAPTER 26
What Is Monetary Policy?
Monetary Policy
The actions the Federal Reserve takes to manage the money supply and interest rates to pursue its economic objectives.
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READING: CHAPTER 26
What Is Monetary Policy?
The Goals of Monetary Policy
The Fed has set four monetary policy goals that are intended to promote a well-functioning economy:
1. Price Stability
2. High Employment
3. Economic Growth
4. Stability of Financial Markets and Institutions
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READING: CHAPTER 26
What Is Monetary Policy?
Monetary Policy Targets
The Fed tries to keep both the unemployment and inflation rates low, but it can’t affect either of these economic variables directly.
The Fed uses variables, called monetary policy targets, that it can affect directly and that, in turn, affect variables, such as real GDP, employment, and the price level, that are closely related to the Fed’s policy goals.
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READING: CHAPTER 26
An Increase in the Money Supply
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READING: CHAPTER 26
The Money Market and the Fed’s Choice of Monetary Policy Targets
A Tale of Two Interest Rates
Why do we need two models of the interest rate?
The answer is that the loanable funds model is concerned with the long-term real rate of interest, and the money-market model is concerned with the short-term nominal rate of interest.
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READING: CHAPTER 26
The Money Market and the Fed’s Choice of Monetary Policy Targets
Choosing a Monetary Policy Target
There are many different interest rates in the economy
For purposes of monetary policy, the Fed has targeted the interest rate known as the federal funds rate.
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READING: CHAPTER 26
The Money Market and the Fed’s Choice of Monetary Policy Targets
The Importance of the Federal Funds Rate
Federal Funds Rate: The interest rate banks charge each other for overnight loans
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READING: CHAPTER 26
Monetary Policy and Economic Activity
Changes in interest rates will not affect government purchases, but they will affect the other three components of aggregate demand:
- Consumption
- Investment
- Net Exports
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READING: CHAPTER 26
Monetary Policy and Economic Activity
The Effects of Monetary Policy on Real GDP and the Price Level: An Initial Look
Expansionary Monetary Policy: The Federal Reserve’s increasing the money supply and decreasing interest rates to increase real GDP.
Contractionary Monetary Policy: The Federal Reserve’s adjusting the money supply to increase interest rates to reduce inflation.
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READING: CHAPTER 26
Monetary Policy and Economic Activity
Can the Fed Eliminate Recessions?
Keeping recessions shorter and milder than they would otherwise be is usually the best the Fed can do.
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READING: CHAPTER 26
A Closer Look at the Fed’s Setting of Monetary Policy Targets
Should the Fed Target the Money Supply?
Some economists have argued that rather than use an interest rate as its monetary policy target, the Fed should use the money supply.
Many of the economists who make this argument belong to a school of thought known as monetarism.
The leader of the monetarist school was Nobel laureate Milton Friedman.
Friedman and his followers favored replacing monetary policy with a monetary growth rule.
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READING: CHAPTER 26
A Closer Look at the Fed’s Setting of Monetary Policy Targets
The Taylor Rule
Taylor rule: A rule developed by John Taylor that links the Fed’s target for the federal funds rate to economic variables.
Federal funds target rate = Current inflation rate + Real equilibrium federal funds rate + (1/2) x Inflation gap + (1/2) x Output gap
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READING: CHAPTER 26
A Closer Look at the Fed’s Setting of Monetary Policy Targets
Should the Fed Target Inflation?
Inflation targeting: Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation.
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READING: CHAPTER 26
How Does the Fed measure Inflation?
In 2000, the Fed announced that it would rely more on the PCE (Personal Consumption Expenditure than on the CPI in tracking inflation. The Fed noted three advantages that the PCE has over the CPI:
1. The PCE is a so-called chain-type price index, as opposed to the market-basket approach used in constructing the CPI. Because consumers shift the mix of products they buy each year, the market-basket approach makes the CPI overstate actual inflation. A chain-type price index allows the mix of products to change each year.
2. The PCE includes the prices of more goods and services than the CPI, so it is a broader measure of inflation.
3. Past values of the PCE can be recalculated as better ways of computing price indexes are developed and as new data become available. This allows the Fed to better track historical trends in the inflation rate.
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READING: CHAPTER 26
The Fed Responds to the Financial Crisis
The Changing Mortgage Market
A financial asset — such as a loan or a stock or bond — is considered a security if it can be bought and sold in a financial market.
When a financial asset is first sold, the sale takes place in the primary market. Subsequent sales take place in the secondary market.
By the 1990s, a large secondary market existed in mortgages with funds flowing from investors through Fannie Mae and Freddie Mac to banks and savings and loans and, ultimately, to individuals and families borrowing money to buy houses.
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READING: CHAPTER 26
The Fed Responds to the Financial Crisis
The Role of Investment Banks
Investment banks began buying mortgages, bundling large numbers of them together as bonds known as mortgage-backed securities, and reselling them to investors.
At the height of the housing bubble in 2005 and early 2006, lenders began to loosen the standards for obtaining a mortgage loan.
Borrowers and lenders were anticipating that housing prices would continue to rise, which would reduce the chance that borrowers would default on the mortgages.
The decline in the value of mortgage-backed securities and the large losses suffered by commercial and investment banks caused turmoil in the financial system.
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READING: CHAPTER 26
The Fed Responds to the Financial Crisis
The Fed’s Responses
First, although the Fed traditionally made loans only to commercial banks, it decided to make primary dealers – firms that participate in regular open market transactions with the Fed – eligible for discount loans.
Second, at the urging of the Fed and the Treasury, Congress passed the Emergency Economic Stabilization Act of 2008, which authorized the Treasury to purchase mortgage-backed securities and other troubled assets from banks.
Third, the Fed and the Treasury took direct action to keep some large financial institutions from bankruptcy.
The financial crisis of 2008 led the Fed and the Treasury to try new approaches to policy. What remains to be seen is whether these new approaches will become part of the policy toolbox or whether policy will return to more traditional approaches.
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READING: CHAPTER 27
Fiscal Policy
What Fiscal Policy Is and What It Isn’t
Fiscal Policy: Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives, such as high employment, price stability, and high rates of economic growth.
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READING: CHAPTER 27
Fiscal Policy
Automatic Stabilizers versus Discretionary Fiscal Policy
Automatic Stabilizers: Government spending and taxes that automatically increase or decrease along with the business cycle.
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READING: CHAPTER 27
The Effects of Fiscal Policy on Real GDP and the Price Level
Expansionary and Contractionary Fiscal Policy: An Initial Look
Expansionary fiscal policy causes the AD curve to shift to the right.
(Real GDP and the Price Level )
Contractionary fiscal policy causes the AD curve to shift to the left.
(Real GDP and the Price Level )
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
Multiplier Effect
Multiplier Effect: The series of induced increases in consumption spending that results from an initial increase in autonomous expenditures.
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
The ratio of the change in equilibrium real GDP to the initial change in government purchases is known as the government purchases multiplier:
Government purchases multiplier =
Change in equilibrium real GDP/Change in government purchases = ∆Y/∆G = 1/(1-MPC)
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
The expression for this tax multiplier is:
Tax multiplier =
Change in equilibrium real GDP/Change in taxes = ∆Y/∆T = -MPC/(1-MPC)
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
Fiscal Policy in Action: The Tax Rebate in 2008
Many economists believe that consumers base their spending on their permanent income, rather than just on their current income. A consumer’s permanent income reflects the consumer’s expected future income.
Consumers who have difficulty smoothing out their consumption spending on the basis of their permanent income are said to be liquidity constrained. The spending of consumers who are liquidity constrained is more likely to depend on their current income than is the spending of consumers who are better able to borrow against their future income. One-time tax rebates, such as those used in 2001 and 2008, increase consumers’ current income, but not their permanent income. Only a permanent decrease in taxes increases consumers’ permanent income. Therefore, a tax rebate is likely to increase consumption spending less than would a permanent tax cut and is likely to have its greatest effect on the spending of consumers who are liquidity constrained.
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
The Effect of Changes in Tax Rates
A cut in tax rates affects equilibrium real GDP through two channels:
(1) A cut in tax rates increases the disposable income of households, which leads them to increase their consumption spending, and
(2) A cut in tax rates increases the size of the multiplier effect.
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
Taking into Account the Effects of Aggregate Supply
(1) An initial increase in government purchases combined with the multiplier effect shifts the aggregate demand curve to the right
(2) Because the SRAS curve is upward sloping, real GDP and the price level are both higher in the new equilibrium.
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READING: CHAPTER 27
The Government Purchases and Tax Multipliers
The Multiplier Work in Both Directions
Increases in government purchases and cuts in taxes have a positive multiplier effect on equilibrium real GDP.
Decreases in government purchases and increases in taxes also have a multiplier effect on equilibrium real GDP, only in this case, the effect is negative.
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READING: CHAPTER 27
The Limits of Using Fiscal Policy to Stabilize the Economy
Does the Government Spending Reduce Private Spending?
Crowding out: A decline in private expenditures as a result of an increase in government purchases
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READING: CHAPTER 27
The Limits of Using Fiscal Policy to Stabilize the Economy
Crowding Out in the Short Run
An Expansionary Fiscal Policy Increases Interest Rates:
(1) As real GDP and income rise, the demand for money increases.
(2) This causes the equilibrium interest rate to rise.
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READING: CHAPTER 27
The Limits of Using Fiscal Policy to Stabilize the Economy
Crowding Out in the Long Run
In the long run, the economy returns to potential GDP.
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READING: CHAPTER 27
Deficits, Surpluses, and Federal Government Debt
Budget deficit: The situation in which the government’s expenditures are greater than its tax revenue.
Budget surplus: The situation in which the government’s expenditures are less than its tax revenue.
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READING: CHAPTER 27
Deficits, Surpluses, and Federal Government Debt
How the Federal Budget Can Serve as an Automatic Stabilizer
Cyclically Adjusted Budget Deficit or Surplus: The deficit or surplus in the federal government’s budget if the economy were at potential GDP.
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READING: CHAPTER 27
Deficits, Surpluses, and Federal Government Debt
Should the Federal Budget Always Be Balanced?
Although many economists believe that it is a good idea for the federal government to have a balanced budget when the economy is at potential GDP, few economists believe that the federal government should attempt to balance its budget every year.
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READING: CHAPTER 27
Deficits, Surpluses, and Federal Government Debt
Is Government Debt a Problem?
Debt can be a problem for a government for the same reasons that debt can be a problem for a household or a business.
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READING: CHAPTER 27
The Effects of Fiscal Policy in the Long Run
The Long-Run Effects of Tax policy
We can look briefly at the effects on aggregate supply of cutting each of the following taxes:
- Individual income tax
- Corporate income tax
- Taxes on dividends and capital gains
Tax Simplification:
There are also gains from tax simplification.
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READING: CHAPTER 27
The Effects of Fiscal Policy in the Long Run
How Large Are Supply-Side Effects?
Most economists would agree that there are supply-side effects to reducing taxes: Decreasing marginal income tax rates will increase the quantity of labor supplied, cutting the corporate income tax will increase investment spending, and so on.
The magnitude of the effects is subject to considerable debate, however.
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UNIT 9 DISCUSSION
Topic 1
In 2008, Federal Reserve Bank Chairman, Ben Bernanke, and U.S. Treasury Secretary, Henry Paulson, responded to the financial crisis by intervening in financial markets in unprecedented ways. Do you think this intervention was necessary? What are the consequences of this intervention? What might have happened if they had not intervened?
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UNIT 9 DISCUSSION
Topic 2
There is always debate regarding the structure of the current income tax system in the U.S. Many opponents of the current system argue that under its current structure, many wealthy households are able to avoid taxes and for most households, the tax system is simply too complicated and confusing. One solution that has been proposed is the “flat tax.” What are the benefits and detriments of replacing the current income tax system with a flat tax system? Who benefits and who might be harmed? What implications does the flat tax system have for tax preparation companies such as H&R Block?
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UNIT 9 ASSIGNMENT
Instructions Summary: Please Read Unit 9 Assignment Instructions
• Please answer the following questions located in the template document. Submit the file as a Microsoft Word ® document to the Dropbox when completed.
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SEMINAR
Read About Graded Seminars
Attending seminars is important to your academic success. They (seminars) will allow you to review the important concepts that are presented in each unit, discuss work issues in your lives that pertain to these concepts, ask your instructor questions and allow you to come together in real time with your fellow classmates.
There will be a seminar in units 1 through 10 in this course. You must either attend the seminar or complete the Alternative Seminar Assignment in order to obtain the points for this part of class.
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UNIT 9 SEMINAR
Unit 9 Alternative Assignment:
• It is strongly suggested that you attend the graded seminar at the regularly scheduled time. If you are unable to attend the seminar, you must complete the following alternative assignment to earn points for this part of the class.
View this week’s archived Seminar and write a 1 page paper, double spaced that summarizes the Seminar and what you learned.
Once completed, submit your alternative assignment to the Seminar Dropbox.
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