1. Macroeconomic Policy Fundamentals
Chapter 13

2. 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

3. 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
Page 299

4. Functions of the Fed 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
Page

5. Location of the 12 District
Federal Reserve Banks
Page 301

6. Changing of the Guard
Alan Greenspan
Ben Bernanke

7. 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
Page 304 – 305

8. Role of the Board of
Governors of the
Federal Reserve System
Page 303

9. Role of the Board of
Governors of the
Federal Reserve System
Page 303

10. Role of the Board of
Governors of the
Federal Reserve System
Page 303

11. Key role played by the
Federal Open Market
Committee or FOMC
Page 303

12. Recent Fed Rate Actions

13. Role of the 12 District
Federal Reserve Banks
located throughout
the country
Page 303

14. Determinants of the Money Supply

15. Existing money supply
curve. Note it is
perpendicular to the
quantity axis, implying
it is unaffected by the
interest rate.
Page 309

16. Expansionary monetary policy
actions will shift the MS
curve to the right over a
period of 12 months or so.
Page 309

17. Contractionary monetary
policy actions, on the
other hand, will shift the
money supply curve to
left over a similar time
period.
Page 309

18. Suppose a depositor in Bank Ag sells $1 million in government securities
to the Fed. He then deposits the proceeds from the sale in his bank. If
the fractional reserve requirement ratio is 20 percent, Bank Ag can
increase the volume of its loans by $800,000. Suppose the proceeds of
these loans are deposited in Bank B. Follow the trail to the Total line.
Page 307

19. Change in the Money Supply
We can skip tracing deposits through the economy by
using 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 with the
brackets is known as the money multiplier.
We can restate this equation in terms of the change in the money supply as follows:
MS = (1.0 ÷ RR) ×  TR = MM × TR
Page 307 – 308

20. 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 the change in the money supply is:
MS = (1.0 ÷ .20) x TR
= 5.0 x $1 million
= $5 million
This results in a change in loans of
loans = MS - TR
= $5 million - $1 million
= $4 million
See bottom line
in Table 13.3
Page 307 – 308

21. = + Change in money supply Change in loan volume Initial infusion
Page 307

22. 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
Greenspan
Page

23. 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 Total reserves decrease
Fed raises the discount rate Total reserves decrease
Fed raises required reserve ratio Money multiplier decreases
Greenspan
Page

24. Determinants of the Money Demand

25. 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.
Page

26. The money demand curve
is given by equation (16.5):
MD = c –d(R) + e(NI)
where R is the rate of
interest and NI is national
income. The coefficient d
is the slope of the curve and
e represents MD÷ NI.
Page 311

27. MD = c –d(R) + e(NI) Increase in income increases demand for money
Page 311

28. rate given by intersection of demand and supply
Money market interest
rate given by intersection
of demand and supply
Page 311

29. MS*
Expansionary
monetary policy
lowers interest
rates
0.06
Page 311

30. MS*
Contractionary
monetary policy
raises interest
rates
0.14
Page 311

31. Page 312 The full effects of this change could take 12 months or more
to register in bank deposits
Page 312

32. Page 312 A change in the money supply will alter the
equilibrium interest rate
in the money market
Page 312

33. Page 312 We know from Chapter 12 that a change in interest
rates will lead to movement
along the planned investment
function….increasing or
decreasing new investment
Page 312

34. Page 312 We also know from Chapter 12 that increased investment
expenditures, a component
of GDP, increases the demand
for labor, lowers unemployment
and thus fuels further growth
in national income…
Page 312

35. Eliminating Recessionary and Inflationary Gaps

36. What is the
magnitude of the
recessionary gap?
Page 313

37. What is the
magnitude of the
recessionary gap?
It is YFE – Y1
Page 313

38. The use of expansionary
monetary 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.
Page 313

39. Recessionary gap
of YFE – Y1 is
partially closed to
YFE – Y3
Inflation rate
(P3 – P0) ÷P0
Page 313

40. The further use of
expansionary monetary
policy to push aggregate
demand from AD3 to AD4
increases real GDP from
Y3 to YFE (full employment
GDP), but increases the
general price level to P4.
Page 313

41. Inflation rate
(P4 – P3) ÷P3
Recessionary gap
fully closed
Page 313

42. The use of expansionary
monetary 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…..
Page 313

43. Microeconomic Interest Rate Implications

44. Interest Rate Impacts on a 10-Year $150K Business Loan
Annual
total PI payment
Annual interest payment
Total interest payment
8 percent
$22,354.69
$7,354.69
$73,546.90
14 percent
28,757.67
13,757.67
137,576.88
20 percent
35,782.44
20,782.44
207,824.40
Page 315

45. Interest Rate Impacts on a 20- Year $100K Home Mortgage
Monthly
total PI
payment
interest
Total
8 percent
$848.78
$432.08
$103,707.46
12 percent
1,115.73
699.06
167,773.46
Page 315

46. 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
Page 316

47. States Without Income Tax
Eight states do not have a state income tax

48. State and Local Taxes
Alaska, thanks to oil reserves, has the lowest tax burden
Maine registering the highest has the highest tax burden
Major sources are sales taxes and property taxes

49. Our focus is on fiscal policy at the federal level….

50. Rising spending and
tax cuts to spur the
economy brought back
budget deficits
Page 318

51. Individuals and not businesses pay the
Bulk of federal taxes.
Page 318

52. The effects of 9/11 and increased spending plus tax cuts to stimulate the economy led to record high deficits…
A strong economy and
controlled spending led
to the first budget surplus
in more than 20 years…
Page 320

53. Recent Trends in Deficit
Typically the economy runs a budget deficit at the federal level
were the exceptions in recent years
Fueled by growing economy and falling interest rates

54. Debt and the Deficit
National debtT = National debtT-1 + DeficitT

55. The growth in federal spending has grown rapidly over the last 20 years…
Page 321

59. Page 322 While the national debt grew as
deficit spending dominated the
1980s and 1990s, debt as a percent
of GDP stayed within post-WW II
experience…
Page 322

60. Federal government spending on Agriculture programs is the fourth highest on this list of total federal spending.

61. 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)
Page 324

62. Impacts of Policy Tools
Expansionary actions: Effects of action:
Cut taxes Increase disposable income
Increase government spending Increase aggregate demand
Congress & Bush
Page 327

63. Impacts of Policy Tools
Expansionary actions: Effects of action:
Cut taxes Increase disposable income
Increase government spending Increase aggregate demand
Contractionary actions: Effects of action:
Increase taxes Decrease disposable income
Cut government spending Decrease aggregate demand
Congress & Bush
Page 327

64. A federal budget deficit requires
the U.S. Treasury to issue more
government securities to balance
sources and uses of funds…
Page 324

65. An increase in the sale of
government securities
reduces the pool of private
capital available to finance
investment expenditures,
raising interest rates…
Page 324

66. We know from Chapter
12 that higher interest
rates depresses investment
expenditures…
Page 324

67. 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
Page 328

68. 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….
Page 328

69. 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….
Page 328

70. 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.

71. 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”

72. Chapter 14 focuses on the key consequences of business fluctuations….