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Principles of Macroeconomics 3250:201
Richard W. Stratton 9/19/2018 The University of Akron
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The University of Akron
Administration 4 graded assignments next week Homework 13, 14 Essay 04 CBT Test 05 (Thursday - Saturday) 9/19/2018 The University of Akron Decision Tree
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The University of Akron
Decision Tree Introduction Student questions Fiscal Policy Monetary Policy Worksheet 13 9/19/2018 The University of Akron
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The University of Akron
Introduction Mixed market economies tend to experience periodic fluctuations in economic activity – business cycles There are strong self-correcting forces in most economies that keep long run economic activity growing 9/19/2018 The University of Akron
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9/19/2018 The University of Akron
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Introduction Question: Is there a need for policies to “counter” the business cycle? This depends on costs of allowing self-correction estimates of how long the self-correction will take costs of government intervention effectiveness of government intervention 9/19/2018 The University of Akron
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The University of Akron
Decision Tree Introduction Student questions Fiscal Policy Monetary Policy Worksheet 13 9/19/2018 The University of Akron
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The University of Akron
Review Readings – Chp. 16 Recall - List 3 main ideas in chapter 16 Summarize – In your own words describe the purpose of chapter 16 Question - Write 1 unanswered question you have from chapter 16 Comment – What is your general impression of this chapter? Connect something in this chapter to your life 9/19/2018 The University of Akron
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The University of Akron
Decision Tree Introduction Student questions Fiscal Policy Monetary Policy Worksheet 13 9/19/2018 The University of Akron
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Decision Tree – Fiscal Policy
Definitions & examples Budgetary Process Scenarios Monetary Policy 9/19/2018 The University of Akron
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Fiscal Policy - definition
Changes in government revenue and/or government expenditures that influence economic activity. Types Automatic stabilizers Discretionary 9/19/2018 The University of Akron
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Fiscal Policy - Automatic stabilizers
Programs that result in anti-cyclical spending or revenue changes Increase G (or decrease tax revenues) as income (GDP) decreases Built-in, need no decision 9/19/2018 The University of Akron
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Fiscal Policy - Automatic stabilizers
Examples Income taxes (induced taxes) As GDP increases, tax revenues increase Needs based spending As GDP increases, government spending on these programs decrease 9/19/2018 The University of Akron
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Fiscal Policy - Discretionary Policy
Deliberate policy changes in G or NT that change AD and AS Requires a conscious decision and action 9/19/2018 The University of Akron
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Fiscal Policy - Discretionary Policy
Examples President Bush’s 2001 tax cut Budget amendments to increase spending on homeland defense Proposals to increase student aid for Higher Ed Changes in the gasoline tax 9/19/2018 The University of Akron
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Decision Tree – Fiscal Policy
Definitions & examples Budgetary Process Scenarios Monetary Policy 9/19/2018 The University of Akron
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Fiscal Policy - Government Budget
Balanced if tax revenue = expenditures Surplus if tax revenue > expenditures Deficit if tax revenue < expenditures 9/19/2018 The University of Akron
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Fiscal Policy - simple multipliers
If only induced spending is consumption Government Purchases Multiplier 1/(1-MPC) Tax Multiplier - MPC/(1-MPC) Balanced Budget Multiplier 1/(1-MPC) - MPC/(1-MPC) 1 9/19/2018 The University of Akron
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Decision Tree – Fiscal Policy
Definitions & examples Budgetary Process Scenarios Monetary Policy 9/19/2018 The University of Akron
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Fiscal Policy Describe the situation depicted LRAS SRAS AD 9/19/2018 The University of Akron
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Fiscal Policy Choose A Tax Policy LRAS SRAS AD 9/19/2018 The University of Akron
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Fiscal Policy Follow The Process LRAS SRAS AD 9/19/2018 The University of Akron
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9/19/2018 The University of Akron
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Fiscal Policy Describe the situation depicted LRAS SRAS AD 9/19/2018 The University of Akron
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Fiscal Policy Choose A Spending Policy LRAS SRAS AD 9/19/2018 The University of Akron
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The University of Akron
Fiscal Policy Follow The Process LRAS SRAS AD 9/19/2018 The University of Akron
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Fiscal Policy Supply side effects? 9/19/2018 The University of Akron
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Fiscal Policy - summary
Write a short paragraph summarizing your understanding of Fiscal Policy 9/19/2018 The University of Akron
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The University of Akron
Review Readings – Chp. 16 Questions Do you have unanswered questions of Fiscal Policy? 9/19/2018 The University of Akron
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Decision Tree – Fiscal Policy
Definitions & examples Budgetary Process Scenarios Monetary Policy 9/19/2018 The University of Akron
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The University of Akron
Decision Tree Introduction Student questions Fiscal Policy Monetary Policy Worksheet 13 9/19/2018 The University of Akron
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Decision Tree – Monetary Policy
Definitions & examples Short-run adjustments Long-run adjustments Fiscal Policy 9/19/2018 The University of Akron
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Monetary Policy - definitions
Changes in money supply (interest rates, monetary base) to influence economic performance Conducted by Federal Reserve Board 9/19/2018 The University of Akron
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Monetary Policy - tools
Fed’s Monetary Policy Tools Federal Reserve Requirement Discount rate Open Market Operations (OMO) Frequency of use? 9/19/2018 The University of Akron
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Decision Tree – Monetary Policy
Definitions & examples Short-run adjustments Long-run adjustments Fiscal Policy 9/19/2018 The University of Akron
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Monetary Policy – short-run
Short-run – Contractionary Policy Fed Sells bonds Reduces Ms (Reserves & Monetary base) Nominal interest rates increase If inflation expectation are constant (real i = nominal i - expected inflation) Actors see increase in nominal i as an increase in Real i 9/19/2018 The University of Akron
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Monetary Policy – short-run
Short-run – Contractionary Policy Actors see increase in nominal i as an increase in Real i Investment, Consumption decrease AD decreases Equilibrium Real GDP decreases Reduced inflationary pressure 9/19/2018 The University of Akron
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Monetary Policy – short-run
Short-run – Contractionary Policy Actors see increase in nominal i as an increase in Real i Foreigners buy dollars, the value of $ relative to other currencies increases, the price of our exports increase Net Exports decrease 9/19/2018 The University of Akron
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Monetary Policy – short-run
Follow The Process LRAS SRAS AD 9/19/2018 The University of Akron
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Decision Tree – Monetary Policy
Definitions & examples Short-run adjustments Long-run adjustments Fiscal Policy 9/19/2018 The University of Akron
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Monetary Policy – Long-run
Saving Supply (SS) and Investment demand (Id) determine Real interest rates Real i = Nominal i - Expected Inflation How are Inflation Expectation formed? 9/19/2018 The University of Akron
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Monetary Policy – Long-run
Inflation Expectation formed from Actual inflation and Ms Thus, Money market influences Expected Inflation 9/19/2018 The University of Akron
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Monetary Policy – Long-run
Nominal (i) = Real (i) + Expected Inflation Monetary policy reduces Expectations of Inflation Saving Supply adjusts (increases) Real (i) decreases 9/19/2018 The University of Akron
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Monetary Policy – Long-run
Real (i) decreases Investment increases AD & Real GDP return to previous levels 9/19/2018 The University of Akron
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Decision Tree – Monetary Policy
Definitions & examples Short-run adjustments Long-run adjustments Fiscal Policy 9/19/2018 The University of Akron
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The University of Akron
Decision Tree Introduction Student questions Fiscal Policy Monetary Policy Worksheet 13 9/19/2018 The University of Akron
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Worksheet 13 What is the state of the federal government budget if the federal government’s expenditures exceed its tax revenues? The federal government budget has a surplus. is in balance. has a deficit. 9/19/2018 The University of Akron
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Worksheet 13 What happens to the federal government debt if the federal government’s tax revenues exceed its expenditures? The federal government debt increases. does not change. decreases. 9/19/2018 The University of Akron
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Worksheet 13 Which branch of government initially proposes and ultimately approves the federal government budget? The President. The House of Representatives. The Senate. The Federal Reserve Board. 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 During a recession retail sales decline causing federal excise tax revenues to decrease. This is an example of what type of economic policy? Discretionary fiscal policy. Discretionary monetary policy. Automatic fiscal stabilizing policy. Automatic monetary stabilizing policy. 9/19/2018 The University of Akron
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Worksheet 13 Which of the following would be an appropriate discretionary fiscal policy response to an inflationary gap? Increase exports. Increase federal government spending to explore space. Increase the federal income tax. Increase Federal Reserve purchases of government securities. 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 What is the document that is used by the Federal Reserve that summarizes current economic conditions? The Council of Economic Advisor’s annual report. Increase federal government spending to explore space. The Beige Book. 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 Which of the following would be an appropriate discretionary monetary policy response to a deflationary gap? Increase exports. Increase federal government spending to explore space. Increase Federal Reserve purchases of government securities. Increase Federal Reserve sales of government securities. 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 In order to lower short-run nominal interest rates, the Fed should increase the purchase of government securities. increase the federal reserve requirement. increase the demand for money. increase the marginal tax rate. 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 If expenditure plans are very responsive to changes in the interest rate and the Fed fears we are in a recession, then the Fed will need to increase the interest rate by a large amount. increase the interest rate by a small amount. decrease the interest rate by a large amount. decrease the interest rate by a small amount. 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 On what date does the federal government’s fiscal year begin? Therefore, the current fiscal year is The fiscal year begins October 1 We are in fiscal year 2005 9/19/2018 The University of Akron
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Worksheet 13 – true/false
The federal government could completely eliminate of the federal government debt in one of three (3) ways. Briefly describe each of the three alternatives and the probable impact each would have on the economy. Increase taxes Void all government debt Fed could buy all government securities and destroys them 9/19/2018 The University of Akron
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Worksheet 13 – true/false
The fluctuation of unemployment compensation payments during a business cycle is an example of what kind of policy. It is automatic fiscal stabilization policy. 9/19/2018 The University of Akron
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Worksheet 13 – true/false
What kinds of government spending might lead to an increase in potential GDP? Spending that increases productivity. For example, improvements to the infrastructure should reduce the private costs of production and increase productivity. 9/19/2018 The University of Akron
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Worksheet 13 – true/false
Under what circumstances might tax reductions lead to inflation? If the tax reductions only impacted AD, then they would tend to cause some inflation as long as the SRAS curve is upward sloping. 9/19/2018 The University of Akron
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Worksheet 13 – true/false
Under what circumstances might tax reductions not lead to inflation? Tax reductions can increase the incentive to be productive. These incentives can increase AS. This will at least reduce the inflationary pressures of the increased AD. Some economists argue tax reductions can be crafted so that these forces on AS are sufficient to eliminate all inflationary pressure. 9/19/2018 The University of Akron
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Worksheet 13 16. Inflationary Gap Deflationary Gap 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 17. What is happening to income tax receipts? 17. Income tax receipts are based on nominal income. Nominal income increases as real GDP and/or prices increases. Real GDP increasing 9/19/2018 The University of Akron
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The University of Akron
Worksheet 13 18. Would restrictive monetary policy allowed the economy to return to potential GDP sooner? 18. No, Restrictive monetary policy would slow the recovery . Real GDP increasing 9/19/2018 The University of Akron
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The University of Akron
Worksheet Y = C + I + G + [X - M] GDP C I G X M NT AE 8000 5175 2000 1100 1500 1400 8375 8500 5550 8750 9000 5925 9125 9500 6300 10000 6675 9875 10500 7050 10250 11000 7425 10625 11500 7800 12000 8175 11375 12500 8550 11750 13000 8925 12125 Equilibrium = 9500 = – 1400 Thus at 8500: Actual < Planned => inflationary gap of $1000 9/19/2018 The University of Akron
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The University of Akron
Worksheet To fill the gap by changing government spending, what would the new level of government spending need to be? 9/19/2018 The University of Akron
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The University of Akron
Worksheet Y = C + I + G + [X - M] GDP C I G X M NT AE 8000 5175 2000 1100 1500 1400 8375 8500 5550 8750 9000 5925 9125 9500 6300 10000 6675 9875 10500 7050 10250 11000 7425 10625 11500 7800 12000 8175 11375 12500 8550 11750 13000 8925 12125 MPC = 0.75; Thus the government spending multiplier is 4. To fill the inflationary gap of $1000, G must decrease by $250. New government spending = $1100 – 250 = $850 million. 9/19/2018 The University of Akron
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The University of Akron
Worksheet To fill the gap by changing taxes, what would the new level of taxes need to be? 9/19/2018 The University of Akron
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The University of Akron
Worksheet Y = C + I + G + [X - M] GDP C I G X M NT AE 8000 5175 2000 1100 1500 1400 8375 8500 5550 8750 9000 5925 9125 9500 6300 10000 6675 9875 10500 7050 10250 11000 7425 10625 11500 7800 12000 8175 11375 12500 8550 11750 13000 8925 12125 MPC = 0.75; Thus the tax multiplier is (0.75/0.25) = 3. To fill the inflationary gap of $1000, Taxes must increase by $333. New taxes = $ = $1433 million. 9/19/2018 The University of Akron
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The University of Akron
Worksheet To fill the gap and keep the balanced budget, what would the new level of government spending and taxes need to be? 9/19/2018 The University of Akron
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Worksheet Y = C + I + G + [X - M] GDP C I G X M NT AE 8000 5175 2000 1100 1500 1400 8375 8500 5550 8750 9000 5925 9125 9500 6300 10000 6675 9875 10500 7050 10250 11000 7425 10625 11500 7800 12000 8175 11375 12500 8550 11750 13000 8925 12125 MPC = 0.75; Thus the balanced budget multiplier is 1. To fill the inflationary gap of $1000 and keep the balanced budget, G and Taxes must decrease by $1000. New government spending = $1100 – 1000 = $100 million. New taxes = $ = $100 million. 9/19/2018 The University of Akron
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The University of Akron
Worksheet To fill the gap using monetary policy, what interest rate should they target? The current interest rate is 4.0%. For each percent change in the interest rate, planned investment changes by $1000 million. 9/19/2018 The University of Akron
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The University of Akron
Worksheet Y = C + I + G + [X - M] GDP C I G X M NT AE 8000 5175 2000 1100 1500 1400 8375 8500 5550 8750 9000 5925 9125 9500 6300 10000 6675 9875 10500 7050 10250 11000 7425 10625 11500 7800 12000 8175 11375 12500 8550 11750 13000 8925 12125 Using monetary policy one might target interest rates to change investment to the desired level. MPC = 0.75; Thus the investment multiplier is 4. To fill the inflationary gap of $1000, I must decrease by $250. Thus interest rates must increase from 4.00% to 4.25% to reduce investment by $250 million. 9/19/2018 The University of Akron
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The University of Akron
Decision Tree Introduction Student questions Fiscal Policy Monetary Policy Worksheet 13 9/19/2018 The University of Akron
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