Macro Test Review (29 March 2011)

Fiscal Policy: government spending, taxes, borrowing

Monetary Policy: controlling the amount of money in circulation and the level of interest rates

Fiscal Monetary
Expansionary Spending ↑, taxes ↓ Reserve requ. ↓, discount rate ↓, open-market purchases ↑
Contractionary Spending ↓, taxes ↑ Reserve requ. ↑, discount rate ↑, open-market purchases ↓
...remember your multipliers!

Important:
Expansionary monetary policy implies money supply ↑, investment ↓, AD and GDP ↑, inflation ↑
Contractionary monetary policy implies money supply ↓, investment ↑, AD and GDP ↓, inflation ↓

Federal Reserve System

1. Discount rate: lead interest rate
2. Reserve requirements: proportion of money holdings a bank has to keep in the “vault”
3. Open market operations: buying/selling bonds from/to private banks and people
Demand-pull inflation

ASLR AS2
AS1
Price Level

P3 c
P2 b
P1 a
AD2
AD1
o Qf Q1
Real domestic output
Cost-push inflation
ASLR AS2
AS1
Price Level

P3 c
P2 b
P1 a
AD2
AD1
o Q2 Qf
Real domestic output
 Definitions
Budget surplus/deficit: government spends more/less (on roads, wars etc.) than it earns through taxes
National debt: current level of indebtedness of a government
Monetization: purchase government bonds to increase money supply without raising interest
Crowding out: government spending ↑, deficit ↑, interest rates ↑, private investment ↓

Problems with public debt

Future income shifted through taxes, foreign-owned debt, crowding out, reduced public investment

Phillips Curve
Annual rate of inflation

Short-run trade-off between inflation and unemployment

7
As inflation declines...
(percent)

6
unemployment
5 increases
4

3
1 2 3 4 5 6 7
Unemployment rate
2 (percent)
1 Laffer Curve
Tax rate (percent)

100
Relationship between
tax rates and tax n
0 revenues

m m
Maximum
Tax
l
Revenue
0
Tax revenue (dollars)