Transcript Chapter 13 Powerpoint

Macroeconomic
Policy
Fundamentals
Chapter 13
Discussion Topics
Characteristics of money
Federal Reserve System
Changing the money supply
Money market equilibrium
Effects of monetary policy on economy
The federal budget deficit
The national debt
Fiscal policy options
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Functions of Money
Medium of exchange – facilitates payment to
others for goods and services
Unit of accounting – assessing profitability of
businesses, household budgets and aggregate
variables like GDP
Store of value – money is a liquid asset which
has value in investment portfolios and cash
flow decisions of businesses and households
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Functions of the Federal Reserve System
Supply the economy with paper currency
Supervise member banks
Provide check collection and clearing services
Maintain the reserve balances of depository
institutions
Lend to depository institutions
Act at the federal government’s banker and
fiscal agent
Regulate the money supply
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Location of the 12 District
Federal Reserve Banks
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The Fed’s Policy Tools
 Reserve requirements – depository institutions
are required to maintain a specific fraction of
their customers’ deposits as reserves.
 Discount rate – rate depository institutions pay
when they borrow from the Fed
 Open market operations – Fed can buy or sell
government securities to alter the money
supply
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Role of the Board of
Governors of the
Federal Reserve System
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Key role played by the
Federal Open Market
Committee (FOMC)
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Recent Fed Rate Actions
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Role of the 12 District
Federal Reserve Banks
located throughout
the country
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Determinants
of the
Money Supply
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Change in the Money Supply
Existing money
supply curve
 Perpendicular to
the quantity axis
 → it is unaffected
by the interest rate
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Change in the Money Supply
Expansionary monetary
policy action will shift MS
curve to the right over a
period of 12 mo. or so.
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Change in the Money Supply
Contractionary monetary
policy actions will shift the
money supply curve left
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 Ag Bank depositor sells $1 million in gov’t securities to the Fed
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 Sale proceeds are deposited in his bank.
 W/ fractional reserve requirement ratio is 20% → Bank Ag
can ↑ the volume of its loans by $800,000.
 Suppose loan proceeds are deposited in Bank B.
 Etc……..
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Change in the Money Supply
We can skip tracing deposits through the
economy via the following money supply (MS)
equation:
MS = (1.0 ÷ RR) × TR = MM × TR
where TR represents total reserves and RR is
the reserve requirement ratio.
 The expression within the parentheses is known as
the money multiplier
 → In terms of the money supply change (ΔMS):
MS = (1.0 ÷ RR) ×  TR = MM × TR
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Change in the Money Supply
 Using the example in Table 13.3 of the $1
million deposit on page 307 and 20% reserve
requirements ratio, we see that ΔMS is
MS = (1.0 ÷ .20) x TR
= 5.0 x $1 million
= $5 million
Table 13.3
bottom line
 This results in Loans of
loans = MS - TR
= $5 million - $1 million
= $4 million
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Change in
money supply
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Change in
= loan volume
Initial
+ infusion
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Impacts of Policy Tools
Expansionary actions:
Effects of action:
Fed buys securities
Total reserves increase
Fed lowers the discount rate
Total reserves increase
Fed lowers required reserve ratio Money multiplier increases
Contractionary actions:
Effects of action:
Fed sells securities
Fed raises the discount rate
Fed raises required reserve ratio
Total reserves decrease
Total reserves decrease
Money multiplier decreases
Bernanke
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Determinants
of the
Money Demand
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Demand for Money
Transactions demand for money – carry
cash to pay for normal expenditures
Precautionary demand for money –
carry cash to cover unexpected
expenditures
Speculative demand for money – hold
cash as an asset in investment portfolios
since the value of cash does not decline
during periods of falling asset prices
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The money demand curve
is given by equation (16.5):
MD = α – β x IR + γ x NI
 R is the interest rate
 NI is national income
 – β is the MD slope (i.e.,
MD÷IR)
 γ represents MD÷ NI
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↑ in income
→ ↑ demand
for money
MD = α – β x IR + γ x NI
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Determination of Interest Rate
Money market interest
rate given by intersection
of demand and supply
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MS*
0.06
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Expansionary
monetary policy
lowers interest
rates
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M S*
0.14
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Contractionary
monetary policy
raises interest
rates
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The full effects of this change
could take 12 months or more
to register in bank deposits
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A change in MS will alter the
equilibrium money market
interest rate
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From Chapter 12
 ΔIR → movement along the
planned investment function
 ↑ or ↓new investment
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From Chapter 12
 ↑ investment expenditures, a
component of GDP
 ↑ demand for labor → ↓
unemployment
 further ↑ in NI
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Eliminating
Recessionary and
Inflationary Gaps
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What is the magnitude
of the recessionary
gap?
 YFE – Y1
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Use expansionary
monetary policy
 Push aggregate demand
from AD1 to AD3
 ↑ real GDP from Y1 to
Y3
 → only ↑ general price
level to P3
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Recessionary gap
of YFE – Y1 is
partially closed to
YFE – Y3
Inflation rate =
% Δ in price =
(P3 – P0) ÷P0
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Use of expansionary
monetary policy to
push AD from AD3 to
AD4
 ↑real GDP from Y3 to
YFE (full employment
GDP)
 ↑general price level to
P4
Recessionary gap
fully closed
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 Use of expansionary
monetary policy to
attain YPOT
 Shift aggregate
demand to AD5
 Will ↑ general price
level to P5
Inflation rate
(P5 – P4) ÷ P4
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Inflationary
gap created
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Microeconomic
Interest Rate
Implications
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Interest Rate Impacts on a 10Year $150K Business Loan
Annual
Annual
Total
Interest Total P & I Interest Interest
Rate
Payment Payment Payment
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8%
$22,354.69
$7,354.69
$73,546.90
14%
28,757.67
13,757.67
137,576.88
20%
35,782.44
20,782.44
207,824.40
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Interest Rate Impacts on a 20Year $100K Home Mortgage
Monthly
Interest Total P & I
Rate
Payment
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Monthly
Interest
Payment
Total
interest
payment
8%
$848.78
$432.08
$103,707.46
12%
1,115.73
699.06
167,773.46
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What is Fiscal Policy?
Taxation by federal, state and local
governments
Government spending by federal state and
local governments
Budget deficit and the national debt
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States Without Income Tax
Eight states do not have
a state income tax
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State and Local Taxes
Alaska, thanks to oil
reserves, has the lowest tax
burden
Maine registered the
highest state tax burden
Major sources are of
government revenue are
sales and property taxes
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Our focus is on fiscal policy at
the federal level….
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↑ spending and tax cuts
recently used to stimulate
the economy resulted in
new budget deficits
Budget deficit = Gov’t
expenditures > receipts
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% of Total Federal Taxes
Individuals vs. Business
Individuals and not businesses pay the
Bulk of federal taxes.
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A strong economy and
controlled spending led
to 1st budget surplus
in more than 20 years
The sub-prime lending
defaults and resulting
financial crisis and
deficit spending have led
to record high deficits…
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Recent Trends in Deficit
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Debt and the Deficit
General formula for the National Debt
National DebtT = National debt(T-1) + DeficitT
A negative deficit is a surplus
The growth in federal
debt has grown rapidly
over the last 25 years
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National debt grew as deficit spending
dominated the last 30 years
Debt as a % of GDP stayed within postWW II levels
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Federal government
spending on Agriculture
programs is the 4th
highest on this list of
total federal spending
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Fiscal Policy Options
Automatic fiscal policy instruments
Take effect without explicit action by
policymakers (e.g., progressive tax rates)
Discretionary fiscal policy instruments
Require explicit actions by the President
or Congress (e.g., passing a law)
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Impacts of Policy Tools
Expansionary actions:
Effects of action:
Cut taxes
Increase government spending
Increase disposable income
Increase aggregate demand
Contractionary actions:
Effects of action:
Increase taxes
Cut government spending
Decrease disposable income
Decrease aggregate demand
Congress & President
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A federal budget deficit requires
the U.S. Treasury to issue more
government securities to balance
sources and uses of funds
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An ↑ in the sale of
government securities
 ↓ the pool of private
capital available to
finance investment
expenditures
 ↑ interest rates
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From Chapter 12
higher interest rates ↓
investment expend.
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The use of expansionary
fiscal policy actions
to push aggregate demand
from AD1 to AD3 increases
real GDP from Y1 to Y3
while only increasing the
general price level to P3.
Inflation rate
(P3 – P0) ÷P0
Recessionary gap
partially closed
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The use of expansionary
fiscal policy to push demand
from AD3 to AD4 increases
real GDP from Y3 to YFE
(full employment GDP),
But increases the general
price level to P4.
Inflation rate
(P4 – P3) ÷P3
Recessionary gap
closed….
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The use of expansionary
fiscal policy to attain
YPOT by shifting aggregate
demand to AD5 will
Increase the general price
level to P5.
Inflation rate
(P5 – P4) ÷P4
Inflationary gap
created….
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Monetary Policy Summary
Functions of money and the role of the
Federal Reserve System in the economy
The money multiplier and the growth of the
money supply
Tools of monetary policy
Demand for money and money market
equilibrium
Policy linkages and timing of full effects
Elimination of recessionary and inflationary
gaps.
Fiscal Policy Summary
Difference between discretionary and
automatic fiscal policy tools
Expansionary and contractionary fiscal
policy actions
Application to eliminating recessionary
and inflationary gaps
Budget deficits, national debt and
concept of “crowding out”