LONG RUN AGGREGATE SUPPLY CURVE
is not affected by price level
change in productivity (increase right, decrease left)
SHORT RUN AGGREGATE SUPPLY CURVE
-not affected by price level
-if increase in price level is expected in the future (decrease, shift left)
-if price level is currently higher than expected because of adjustment to past errors in expectations about future prices (decrease, shift left)
-un
WHY DOES SRA SLOPE UPWARDS?
-Prices of final goods rise more quickly than the prices of inputs
-Firms and workers fail to predict changes in the price level
-Contracts keep wages "sticky
When economy is at macroeconomic equilibrium
-total unemployment=frictional unemployment+structural employment
-SRAS=AD=LRAS
-actual GDP=potential GDP
A Supply Shock
is a sudden increase in the price of an important natural resource, resulting in a leftward shift of the SRAS curve
Stagflation
a combination of inflation and recession that occurs when a supply shock shifts the SRAS to the left, increasing the price level and decreasing actual GDP
In the short run an increase in aggregate demand
increases the price level and actual GDP beyond potential GDP
In the long run an increase in aggregate demand
the economy back to potential GDP but the price level remains higher
M1
travelers checks+amount in currency+checking account balances
M2
M1+saving account balances+small denomination time deposits+money market deposit accounts in banks+non institutional money market fund shares
Reserves
Deposits that a bank keeps as cash in its vault or on deposit with the Federal Reserve
Required Reserves
Reserves that a bank is legally required to hold, based on its checking account deposits
Required Reserve Ratio
The minimum fraction of reserves that banks are required by law to keep as reserves
Excess Reserves
Reserves that banks hold over and above the legal requirement
An initial increase in a bank's reserves will increase checkable deposits
by an amount greater than the increase in reserves
The Simple Deposit Multiplier
is greater than the real-world deposit multiplier.
Bank Run
a situation where many depositors simultaneously decide to withdrawal money from a bank
Bank Panic
a situation in which many banks experience bank runs at the same time`
Federal Reserve
uses the following tools to manage the money supply:
1. Open Market Operations-the buying and selling of treasury securities to control the money supply. Buying treasury securities increases the money supply while selling them decreases it.
2.Discount Pol
Velocity of money
GDPxPrice/Money Supply
Quantity Theory of Money
A theory of the connection between money and prices that assumes that the velocity of money is constant
Monetary Policy
The actions the Federal Reserve takes to manage the money supply and interest rate
Monetary Policy Goals of the Fed
1. Price stability (not low prices)-Rising prices erode the value of money as a medium of exchange and as a store of value. Current and former chairmen of the Federal Reserve argue that if inflation is low over the long run, the Fed will have the flexibil
Buying US Treasury Securities
Increases money supply. People and banks sell the securities and deposit the money into banks. Bank's reserves increase, loans increase, and checkable deposits rise. This expands money supply. If FOMC wishes to decrease the supply, it sells those securiti
Fed Targets
Can target money supply or interest rate, but tends to target interest rate more recently, ESPECIALLY the federal funds rate.
Federal Funds Rate
The interest rate banks charge each other for overnight loans.
-FFR is determined by the forces of supply and demand for excess reserves, the Fed can influence the amount of reserves in the banking system. It sets a target for the federal funds rate.
-the
When the Fed increases the money supply
the short-term interest rate must fall until it reaches a level at which firms and households are willing to hold the extra money
Short-term nominal interest rate
when conducting monetary policy, the short term nominal interest rate is the most relevant, because, unlike the long-term real interest rate, it is the rate most affected by the changes in the money supply.
Money Demand Curve
changes in real GDP or the price level cause the money demand curve to shift.
-an increase in real GDP means that the amount of buying or selling will increase. The increase in buying and selling increase the demand for money as a medium of exchange. Hous
An increase in the required reserve ratio would cause...
AD to shift to the left, with a lower price level and lower output
If the Fed enacts a policy to decrease the discount rate in long run equilibrium then in the short-run...
AD would shift to the right with a higher price level and a higher output.
Contractionary Monetary Policy
the price level and real GDP both fall, unemployment rises
-increasing the reserve requirement
-increasing the discount rate
-conducting an open market sale of government securities
--as a result of this action the money supply contracts and interest rate
Expansionary Monetary Policy
the price level and real GDP both rise, unemployment falls
-decrease in the discount rate
-decrease in the reserve requirement
-open market purchase of government securities
Enact a policy to get AD to the right
decrease discount ate, decease the reserve requirement or conduct an open market purchase of government securities
Procyclical Policy
If the Fed is late in recognizing a recession, the implementation of an expansionary monetary policy to reduce the severity of the recession could potentially take effect during the next expansion.
-an expansionary policy put in place too late (because di
Inflation Targeting
conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflations
Arguments in favor:
1. Real GDP returns to its potential level
2. Households and firms have accurate expectations of the future price level
3
Monetarism
Believe the Fed should target the money supply and not the interest rate (increase money supply at a constant rate, equal to long-run growth rate of real GDP (3.5%), regardless of the state of the economy), and adopt the monetary growth rule.
Taylor Rule
Federal funds target rate = Current inflation rate + Real equilibrium federal funds rate + ((1/2) x Inflation gap) + ((1/2) x Output gap).
inflation gap: difference between current inflation rate and targeted inflation rate
output gap: the percentage diff
Investment Banks differ from commercial banks because
Investment banks do not take deposits, investment banks generally do not lend to households
What causes a movement on the AD curve?
The interest rate effect and wealth effect
According to the AD/AS model, what is the most common cause of inflation?
AD increases by more than LRAS
Total spending increases faster than total production
Five Criteria to make a good a suitable medium of exchange
1. The good must be acceptable to (that is, usable by) most people.
2. It should be of standardized quality so that any two units are identical.
3. It should be durable so that value is not lost by spoilage.
4. It should be valuable relative to its weight