Macroeconomics 1

The use of taxes, government transfers, or government purchases of G&S to shift the aggregate demand curve. The Government controls G directly and influences C and I through taxes and transfers.

increases AD (“extra fuel for the economy”) shift to the right if

• Increase in government spending
• Cut in taxes
• Increase in government transfers

decreases AD (“brakes for the economy”) shift to the left if:

• Reduction in government spending
• Increase in taxes
• Reduction in government transfers

Taxes that do not depend on the taxpayer’s income

Change in government spending or taxes with the purpose to expand or shrink the economy as needed.

An estimate of what the budget balance would be if the economy were at potential output. It varies less than the actual budget deficit.

Spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics. (e.g. Social Securities)

Instead of finding trading partner to exchange G&S (barter system), money always takes one side of the trade

1. Medium of Exchange: Something people accept as payment for G&S.
2. Store of Value: Money (and every other asset!) is a mean of purchasing power over time. It enables people to save the money to buy G&S in the future.
3. Unit of Account: Money provides a yardstick for measuring and comparing the values of a wide variety of goods and services.

Commodity Money: A good with intrinsic value (Eigenwert) used as a medium of exchange (e.g. cigarettes for trading during WWII).

Commodity-Backed Money: Paper currency with no intrinsic value, but it promised that it ca be converted into valuable goods. Advantage: it allowed society to use commodity resources (e.g. gold and silver) for other purposes.

Fiat Money: Money whose value derives entirely form it s official status as a means of payment. Risk: Counterfeiting (Fälschen, Geld fälschen).

An overall measure of the money supply

M1: Contains only the most liquid forms of money (currency in circulation or cash, checkable bank deposits, traveler’s checks)

M2: Includes M1 plus near-moneys (financial assets that cannot be traded directly but converted into cash or checks immediately)

if many depositors try to withdraw their funds due to fears of a bank failure

1. Deposit Insurance: Guarantees depositors will be paid even if bank cannot come up with funds. Up to a max. amount per account. (USA: $250’000, CH: CHF 100’000)
2. Capital Requirements: Requirement that the owners of banks hold substantially more assets than the value of bank deposits.
3. Reserve Requirements: Rules set by the Federal Reserve that determine the minimum reserve ratio for a bank (USA: min. reserve ratio is 10%)
4. Discount Window: Arrangement in which Federal Reserve stand ready to lend money to banks in trouble, thus bank is not forced to sell its assets at fire-sale prices

Not covered by insurance or any bank regulations! E.g. Investment banks, insurance companies, hedge fund companies, money market fund companies

Sum of currency in circulation and bank reserves

1. Reserve Requirements: The federal funds market allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves. The federal funds rate is the interest rate determined in the federal funds market.
2. Discount Rate: Allows banks that fall short of the reserve requirement to borrow funds from the FED via the discount window. The discount rate is the rate of interest the FED charges on those loans. The discount rate is usually higher that the federal funds rate
3. Open-Market Operations (most important): When FED buys and sells primarily U.S. Treasury securities on the open market in order to regulate the supply of money that is on reserve in U.S. banks, and therefore available to loan out to businesses and consumers. They are the principal tool of monetary policy!

If FED wants to increase the money supply (expansionary OMO), it will buy T-bills to banks:

- to pay T-billy, FED electronically increases the reserves of the seller
- With more reserves, banks increase loans
- Money supply increases as the loans/money creation process ripples through the economy

If FED wants to decrease the money supply (contractionary OMO), it will sell T-bills to banks:

- In exchange for the T-bills, FED decreases the reserves of the seller
- With fewer reserves, bank decrease loans
- Money supply decreases as the loans/money creation process ripples through the economy in reverse.

Lending to home-buyers who do not meet the usual criteria for being able to make the mortgage payments. (helped creating the housing bubble).

Model, where MD Curve and MS Curve intersect.

Price Level: Other things equal, the demand for money is proportional to the price level: Higher prices shift the MD curve to the right and lower prices to the left.

Real GDP: More G&S produced and sold means we need more money: An increase in real GDP shifts the MD curve rightward, a decrease leftward

Credit Markets & Bank Technology: The need for cash has been reduced by a series of innovation (ATM’s, Twint, Online Banking, PayPal etc.): It’s easier to make purchases without cash, thus shifting the MD curve to the left.

Institutions: If banks increase the interest rate on their accounts, it reduces the cost of holding money, shifting the MD curve to the right.

The FED can shift the MS curve by performing open-market operations to increase or decrease the money supply.

Increasing MS and driving interest rate down by purchasing T-bills or decreasing MS and driving interest rates up by selling T-bills.

In the short run, an increase in the money supply reduces the interest rate which leads to a short-run increase in real GDP and an increase in the supply of loanable funds.

Changes in the money Supply. Main tool of macroeconomic stabilization because to fewer lags than fiscal policy.

increase the MS ► increases the aggregate demand

decrease the MS ► decreases the aggregate demand

Central bank uses inflation targeting by setting an explicit target for the inflation rate and sets monetary policy in order to hit that target.

Changes in the money supply have no real effect on the economy, only on the aggregate price level.

In the long run, the macro equilibrium is back again at its previous position, but the aggregate price level is higher than before.

The Short-Run Philips Curve is the negative short-run relationship between the unemployment rate and the inflation rate. Because this relationship is negative, the curve slopes downward.

→SRPC shifts rightward when the SRAS shifts leftward:

• negative supply shock
• increase in expected inflation
• staglfation

←SRPC shifts leftward when the SRAS shifts rightward:

• positive supply shock
• decrease in expectd inflation

When conventional monetary policy is ineffective because the nominal interest rate is up against the zero-lower bound. Could always appear if there’s a sharp reduction in demand for loanable funds. Monetary policy is ineffective

Flexible prices and focus on the long run mean a vertical SRAS curve; shifts in AD affect only aggregate price level.

Sticky prices and upward-sloping SRAS curve; shifts in AD affect the price level and output

asserts that GDP will grow steadily if the money supply grows steadily.

Monetarists asserted that:
- Attempts to stabilize the economy with fiscal or monetary policy would make things worse.
- GDP would grow steadily if the money supply grew steadily

The use of changes in the interest rate or the money supply to stabilize the economy.