Macroeconomics 201 Answer all 25 multiple choice questions..docx

Macroeconomics 201
Answer all 25 multiple choice questions.
1. Which is not a function of money?
a) unit of account; b) medium of exchange; c) means of
measure; d) store of value
2. Since the 1980s, it has generally been the view that the
money supply:
a) is completely controlled by the central bank;
b) cannot be controlled by the central bank;
c) is completely controlled by the Treasury;
d) cannot be controlled by the Treasury
3) Which of the following is not one of the three kinds of
demand for money in Keynes?
a) speculative;
b) precautionary; c) administrative;
d) transactions
4) Which of the following is not one of the ways the Fed can
use to try to affect the money supply?
a) change the discount rate;
b) change the fed funds rate;
c) change the reserve requirement ratio;
d) open market operations
5) Expansionary policy is used to:
a) try to fight inflation;

b) try to decrease output, income, and employment;
c) try to increase output, income, and employment;
d) try to increase deflation
6) There is a tension between these two characteristics of banks
in a fractional reserve banking system:
a) private profit seeking enterprises and susceptible to runs;
b) private profit seeking enterprises and engage in money
creation;
c) engage in money creation and susceptible to runs;
d) engage in runs and susceptible to money creation
7) The liquidity trap is:
a) the horizontal portion of the money demand function;
b) when interest rates are so low people do not think they can
go any lower;
c) when interest rates are insensitive to changes in the Money
supply;
d) all of the above
8) The limits to KEMP are:
a) I may be insensitive to changes in i, i may insensitive to
changes in Ms, Y may be insensitive to changes in I;
b) I may be insensitive to changes in Y, I may be insensitive to
changes in i, i may be insensitive to changes in Ms;
c) I may be insensitive to changes in i, i may be insensitive to
changes in Ms, Y may be insensitive to changes in i;
d) I may be insensitive to changes in i; Ms may be insensitive to
changes in i, Y may be insensitive to changes in I
9) The limits to KAIMP are:

a) only works for demand-pull inflation, Fed may overshoot its
mark and cause a recession;
b) only works for cost-push inflation, Fed may overshoot its
mark and cause a recession; c) only works for demand-push
inflation, Fed may overshoot its mark and cause a recession;
d) only works for cost-pull inflation, Fed may undershoot its
mark and cause a recession
10) In the endogenous view of the money supply:
a) the Ms curve is vertical;
b) the Ms curve is horizontal;
c) the Md curve is vertical;
d) the Md curve is horizontal
11) Deficit Hawks view deficits as causing:
a) high investment rates; b) deflation; c) high interest rates; d)
all of the above
12) Deficit Doves believe that:
a) deficits cause high interest rates;
b) high interest rates cause bigger deficits;
c) deficits are always good;
d) all of the above
13) In the functional finance view, bond sales:
a) finance deficit spending;
b) add to bank reserves depleted by deficit spending;
c) drain excess reserves to maintain short term interest rates;
d) none of the above
14) In the functional finance view, taxes:

a) finance government spending;
b) create a demand for government bonds;
c) create a demand for government currency;
d) all of the above
15) In the functional finance view:
a) the government needs the public’s money to spend;
b) the public needs the government to accept its money;
c) the government needs the public to need its currency;
d) both b and c
16) The view that the national debt is a burden on future
generations is held by:
a) deficit hawks; b) deficits doves; c) functional finance; d) a
and b
17) The view that the government is the monopoly issuer of the
currency is held by:
a) deficit hawks; b) deficit doves; c) functional finance; d) b
and c
18) Which describes KEMP:
a) Ms↑ ( i↑ ( I↑ ( Y↑;
b) Ms↑ ( i↓ ( I ↓-- Y↑;
c) Ms↑ ( i↓ ( I↑( Y↑;
d) Ms↑ ( i↓ (I↑ ( P↓
19) In the endogenous money view:

a) deposits create loans;
b) reserves create loans;
c) loans create deposits;
d) deposits create reserves
20) The most common method the Fed uses to try to affect the
money supply is:
a) reserve requirement ratio; b) discount rate; c) open market
operations; d) fed funds rate
21) What are the tools of monetary policy?
a) government spending and taxes;
b) money supply and interest rates;
c) money demand and interest rates;
d) government supply and tax rates
22) In the endogenous view of the money supply, everything
begins with:
a) the supply of credit;
b) the demand for credit;
c) the supply of loanable funds;
d) none of the above
23) The Fed can try to increase the money supply by:
a) selling discount rates;
b) buying discount rates;
c) selling bonds;
d) buying bonds

24) The Fed can try to decrease the money supply by:
a) raising the discount rate;
b) lowering the discount rate;
c) lowering the reserve requirement ratio;
d) raising the money supply
25) When money is used to settle debt it is functioning as:
a) a means of purchase;
b) a means of value;
c) a means of payment;
d) a medium of account
PAGE
1
Government Budgets and the National Debt.ppt
Government Budgets and the National Debt
Three Paradigms for Evaluating Budgetary Policies
Government Budgets and the National Debt
Three are three general paradigms concerning government
deficits and the national debt:
Deficit Hawk, Deficit Dove, and Functional Finance.
First, let’s keep in mind some basic definitions.The government
budget is the relation between government spending, G, and tax

revenues, T, in one year.
If G = T then this is a balanced budget.
If G > T, there is a budget deficit.
If G < T, there is a budget surplus.
The National Debt is the accumulation of all past deficits (and
surpluses).
Deficit Hawk View
Deficit Hawks take the view that budget deficits and the
national debt are almost always and everywhere bad for the
economy. The deficit hawk argument usually includes some
combination of the following five points.
Deficit Hawks
1. Deficits cause inflation – Because most Hawks accept the
basic neoclassical theory, they view the economy as tending to
full employment. Since budget deficits increase aggregate
demand, they will tend to set off inflationary pressures in a full
employment—or near full employment—economy.
Deficit Hawks
2. Deficits cause high interest rates – Accepting the neoclassical
view of savings and investment and interest rate determination,
Hawks view government spending that is financed by borrowing
(i.e., deficits), to be coming out of a fixed ‘pool’ of savings.
Government is thus competing with the private sector for
savings, bidding up interest rates.

Deficit Hawks
3. Deficits ‘crowd out’ private spending – Related to the
previous points, if government and the private sector are
competing for a fixed pool of savings to finance their spending,
government spending financed by borrowing decreases the
resources leftover for financing private expenditure. Thus any
increase in deficit spending “crowds out” (is exactly offset by)
decreases in private spending. And if the economy is at Yf,
government can only employ resources if they are taken away
from their employment in the private sector.
Deficit Hawks
4. The national debt is a burden on future generations. They
have to pay the debt.
Deficit Hawks5. Government deficits and debt are generally
immoral. Hawks often make an
analogy between government deficits and debt and household or
business debt.
Deficit Doves
Take the view that deficits can be okay under certain
circumstances—it depends on the economic context. But Doves
also devote a lot of attention to issues of defining and
measuring deficits and the debt, often arguing that they are not
as big as they might appear.

Deficit Doves
1. Are deficits being measured in constant or current dollars?
Doves argue that it is
wrong to compare deficits between years in current dollars,
because the value of the dollar has changed. One way of
correcting for this is to look at deficit/GDP ratios (and
debt/GDP ratios). These ratios are also important for Doves,
because they argue that a larger GDP means we can afford a
bigger deficit or debt.
Deficit Doves
2. The Federal Government doesn’t keep a capital account. So
when there is a large capital expenditure it looks like a lot has
been paid out in this period and the budget doesn’t reflect the
services that will last for years.
Deficit Doves
3. The Government owns assets. The Government may have a
debt, but it also owns asset land, buildings, stocks, gold, water
sewage treatment plants, hospitals, schools, etc.
Deficit Doves
4. State and Local Budgets often not considered. Often the
Federal budget is discussed, even though historically Federal
deficits have been offset by surpluses at the State and local
levels.
Deficit Doves

5. Government agencies own government debt. It is argued that
in this case, we really do “owe it to ourselves.”
Deficit Doves
6. We should examine the “full employment deficit” Doves
argue that much of the deficit is due to unemployment. When
there is unemployment, income is lower, so tax revenues are
lower, and government spending on various assistance for the
unemployed is higher.
Deficit Doves
7. Balance budget over the business cycle, rather than in one
year. Doves argue that one year is an arbitrary amount of time.
Instead, it makes more sense to run deficits during recessions
and surpluses during booms, so that the budget is balanced over
the cycle and debt is not growing.
Deficit Doves
8. Debt is not a burden on future because we are also creating
assets for the future.
Doves also argue that the debt will be paid to those in the future
as well.
Deficit Doves
9. Doves argue that if deficits and high interest rates are
correlated, the causality
goes the opposite way—from high interest rates to big deficits.
When interest rates are high, interest payments are high,

pushing deficits higher.
Deficit Doves
10. To the extent the analogy with households and firms is
applicable, Doves think it supports their view. Well-managed,
responsible debt is not a bad thing for households and firms—
same with government.
functional finance
The Functional Finance view says both Hawks and the Doves
are wrong.
functional finance
1. In a Modern Money system, the purpose of taxation is to
create a demand for—and give a value to—unbacked currency.
functional finance
2. The Federal Government is the monopoly issuer of the
currency. The
government doesn’t need the public’s money; the government
needs the public to need its money to give it value.
functional finance
3. The purpose of bond sales is not to finance spending, but to
drain excess reserves created by deficit spending. This is
necessary to maintain positive short term interest rates.

functional finance
4. In the functional finance view, the relation of G and T
doesn’t matter – all that matters are the effects of any policy.
functional finance
5. “Printing money” can have no effect on the economy
independently of the six different fiscal operations (taxing,
spending, giving, taking, lending, and
borrowing). To consider the effects of printing money and these
six would be to
double count.
functional finance
6. The sound money, sound finance view of the Hawks treats the
modern money
system as if it were a gold standard. The gold standard is a
fixed exchange rate system; modern money is (and must be) a
flexible exchange rate system—not only no gold standard, but
no currency board, no pegged currencies, no fixed exchange
rates of any kind.
functional finance
7. Doves are wrong because by saying that the deficit is not
really as big as it seems, or that we can balance the budget over
the cycle, they are giving in to the Hawk view that it matters
whether we deficit spend, how big the deficit or debt is, and
whether we balance or not!

functional finance
8. The deficit is just accounting information – it tells us how
much the public wants to ‘net save’. In a closed economy, (G –
T) = (S – I), that is, the public deficit equals the private surplus.
functional finance
9. The national debt is just accounting info. It is the record of
government’s draining of excess reserves to maintain short term
interest rates. It might be better called the “IRMA” (interest
rate maintenance account) than the national debt.
functional finance
10. The national debt is not a burden on the future, because
there can be no
financial burden on a state money monopolist.
Macro Policy Debates1.ppt
Macro Policy Debates
neoclassical monetarists, Keynesians, and supply-side
economics
Quantity Equation
MV = PY (sometimes MV = PQ or MV = PT)

M = money supply
V = velocity of circulation of money (how many times a dollar
changes hands per year)
P = price level
Y = real output
Quantity Equation
MV = aggregate spending
PY = total value of sales
Since every purchase is a sale, must be true by definition
Quantity Equation
MV = PY
It is actually an “identity”—meaning it is true by definition.
Therefore, differences must come from the way the variables are
interpreted, and the conclusions derived from the
interpretations.
Quantity Equation
Suppose there is $20 in the economy.
So M = 20. And I have it.
I use it to buy some milk from you.
I buy 5 gallons at $4 per gallon.
Then, in the same time period, you buy one economics textbook
from me for $20.

Quantity Equation
First Round Second Round
M = 20 same M
V = 1 V = 1
P = $4 P = $20
Y = 5 Y = 1
Quantity Equation
M = $20 and there was a total of 2 transactions, so MV = $40.
P in the first round was $4 and Y in the first round was 5, so PY
in the first round was $20. In the second round, PY is 20 x 1 =
$20.
$20 + $20 = $40.
Monetarists
Monetarists claim that V is constant or stable (predictable).
Therefore, if M increases PY increases, if M decreases PY
decreases. But monetarists are neoclassicals, so they believe
that output is at full employment in the long run, so Y is also
fixed (natural rate of growth and self-adjusting to full-
employment). Thus there is a direct relation between the money
supply and the price level. And causality goes from M to P. So:
If M increases, P increases.
If M decreases, P decreases.
Monetarism
Since monetarists view V as constant, they hold the position
that fiscal policy cannot result in any change in aggregate
spending. Increases in government spending are offset by

corresponding decreases in private expenditure. If the increase
in government spending is financed by taxes, they argue that
this will decrease disposable income and thus reduce spending.
The drop in Yd will be divided between a drop in C and a drop
in S. The drop in S will result in less I, so that the fall in C + I
will exactly offset the rise in G—crowding out.
Monetarism
If the government expenditure is financed by borrowing, then
this decreases the loanable funds available for private
borrowing for investment and the purchase of consumer
durables. This increased competition for a fixed pool of savings
bids up the interest rate. So, for the monetarists, increased
government expenditure necessarily means decreased private
expenditure. ‘Crowding-out'.
MonetarismSo monetarist policy is for minimal government
expenditures (police, military, etc.). Increase the money supply
at 3% per year, since that is what they believe the natural rate
of growth is- 3%. So if Y is growing at 3% per year, we
increase the money supply by 3% per year so there will be just
enough aggregate demand to buy the national output, but not out
of control inflation. Velocity is supposed to be growing at a
constant rate of 3% per year, so P will also be constant at 3%
per year.
Keynesians
For Keynesians, things are much more variable. First, Y does
not tend to Yf, so it is likely to be below Yf. There are two
versions of the Keynesian story, with exogenous Ms and

endogenous Ms. With exogenous Ms, fiscal policy either
depends on V being variable, or must be accompanied by
complementary monetary policy. As far as V, we can think
about the multiplier. Keynesians believe that V is variable.
The multiplier affect is not the result of an increase in the
money supply; rather it depends on the changeability of V. The
same dollar, so to speak, turns over more times in a given time
period. The monetarists are right when they say that if V were
constant, there could be no increase in aggregate spending
without an increase in the money supply. It's just that the
monetarists have been unable to prove that V is constant. They
have conceded, in the face of empirical evidence, that V is
variable in the short run.
KeynesiansKeynesians also disagree in their interpretation of Y.
They of course say that Y will likely be at a below full-
employment equilibrium. Therefore fiscal and monetary policy
may affect Y, unless at Yf, then P will be affected. Obviously
if we are at full-employment, then P will rise if aggregate
spending rises. With an endogenous Ms, the increase in G
increases Y, if Y is less than Yf, and the Ms increases
endogenously.
Keynesians
But if we are at less than full employment, then an increase in G
will not crowd out private expenditures, because the increased
expenditure is in effect utilizing unused resources, not taking
them away from the private sector. Same with an increase in
M- it can result in an increase in Y.

Keynesians
If the increase in G is financed by taxes, the monetarists say
that it will be crowded out due to the decrease in disposable
income. But this misses the whole point of the balanced budget
multiplier. If it is financed by borrowing, the monetarists argue
that this reduces the loanable funds available for borrowing.
But Keynesians don't believe that investment is financed out of
a pool of savings, nor that the interest rate is determined by S
and I (modern forms of credit, etc.). So i won't be bid up,
either.
Keynesians
Fiscal policy works because either:
1) Y increases by V increasing;
2) Y increases leading to M increasing, either:
a) because coordinated with monetary policy;
b) M increases by fiscal policy;
c) causality runs from Y to M
(endogenous money)
Stagflation
simultaneous recession and inflation
1970s
Keynesians criticized because they were accused of not being
able to explain stagflation, supposed to be a trade-off between
unemployment and inflation; not supposed to be able to have
both

stagflationThe reason that Keynesians were supposedly unable
to explain stagflation is because, traditionally, unemployment
was due to insufficient aggregate demand and inflation was due
to excess aggregate demand. How can you have too much and
too little of something at the same time?
stagflation
We can use the aggregate supply-aggregate demand (AS-AD)
analysis to look at the stagflation issue. We will assume for
now a textbook aggregate demand curve (with real balance
effects and so downward sloping to the right). The aggregate
supply curve in the following graph is a Keynesian one,
horizontal up to full employment and then vertical.
AD-AS Analysis
P
Y
AS
AD1
P*1
Ye*2
Yf
P*3
0
AD2
AD3
stagflation
Start at Yf, with the price level at P*1. Insufficient aggregate
demand would shift the AD curve in from AS1 to AS2, and

output, income, and employment would drop to Ye*2. Excess
aggregate demand would shift the AD curve out from AD1 to
AD3, causing prices to rise from P*1 to P*3. So there can be
either unemployment or inflation, but not both.
StagflationThe Keynesian reply was simple. If the inflation was
due, not to excess demand but to supply-side factors, in other
words if it was cost-push rather than demand-pull inflation, then
stagflation is easy to explain. In that case, rising costs, such as
due to the OPEC oil crisis, shifts the AS curve up, causing a
recession with rising prices.
AD-AS Analysis
P
Y
P*1
Ye*1
P*2
0
AS1
AS2
Ye*2
The Decline of Keynesianism and the Rise of Supply-Side
Economics
But it was too late for Keynesian economics. Stagflation was
just the straw that broke the paradigm’s back. With the election
of Ronald Reagan as President in 1980, supply-side economics
would be given a chance.

MONEY.ppt
MONEY
Monetary History,
Theory, and Policy
What is Money?Many definitionsAt the end of the day, money
is anything that functions as moneyWhat are the functions of
money?
functions of money
Unit of account – means of measuring the comparable worth of
goods and services; standard of value
Medium of exchange – a. means of purchase (money exchanges
directly for goods and services); b. means of payment (means of
settling debt)
Store of value – means of accumulating wealth; money as an
end-in-itself
fractional reserve bankingIn a fractional reserve banking
system, banks keep some fraction of total deposits on reserve to
meet the normal demand of depositorsThe fraction of deposits
kept on reserve are required reserves, the remaining portion of
deposits are excess reserves and are available for lending and
investing

characteristics of fractional reserve banking system
Banks are private, profit-seeking enterprises;
Through lending, spending, and redepositing, banks affect the
money supply;
Banks are susceptible to a run on the bank
Tension between #1 and #3: banks want to earn profits, and so
want to lend reserves, but don’t want to be vulnerable to a run,
so don’t want to lend too much
Central banksIn U.S., the Federal Reserve, or “Fed”A central
bank is like a bank for private banks:
1. lend reserves to private banks – they charge interest on
loans, called the discount rate
2. hold private banks’ reserves
demand for moneyTransactions demand – stable, determined by
mpc and conventionPrecautionary demand - stable, determined
by mpc and conventionSpeculative demand – determined by
relation between two rates of interest:1. current actual rate
(ic)2. expected future rate (ie)
speculative demand To understand how the speculative demand
for cash is determined by the relation of the two rates of
interest, must understand:1. investor motto: buy low and sell
high2. inverse relation between bond prices and interest rates

speculative demandIf ic < ie then people think that interest rates
are going to go up, so they think that bond prices are going to
go down, so they sell bonds and hold cash (speculative demand
for cash is high)If ic > ie then people think that interest rates
are going to go down, so they think that bond prices are going
to go up, so they buy bonds with all available cash (speculative
demand for cash is low)
Money Demand
Interest Rate
Quantity of Money
MD
i
0
three ways central bank can attempt to affect the money supply
Set reserve requirement ratio - % of deposits banks must keep
on reserve (least used method; money supply is too sensitive to
changes in rrr)
Set discount rate – rate of interest charged for borrowing
reserves (intermediate method – 5-7 times per year)
Open market operations – buying and selling bonds (used most
often; daily)
methods of attempting to control the money supplyTo try to
increase the money supply:decrease rrr; decrease d.r.; buy
bonds
To try to decrease the money supply:increase rrr; increase d.r.;
sell bonds

money supplyIf the central bank is able to control the money
supply, the money supply is “exogenous,” and the money supply
curve is vertical.
Exogenous Money Supply
Money Supply (Ms)
Interest Rate
Quantity of Money
i
M1
0
Shift inward of Money Supply (Exogenous Money Supply)
Ms1
Interest Rate
Quantity of Money
Ms2
M1
M2
0
Shift outward of Money Supply (Exogenous Money
Supply)
Ms1
Interest Rate
Quantity of Money
Ms2

M1
M2
0
money supplySince the mid-1980s, it has become widely argued
that the central bank cannot control the money supply, and that
the money supply is “endogenous,” so that the money supply
curve is horizontal. In this case, the money supply is
determined by market forces, in particular the demand for
money or the demand for credit. In this case, it is the short-term
interest rate that central banks control directly.
Endogenous Money Supply
Ms1
Interest Rate
Quantity of Money
i
0
endogenous money supplyIn this view, when households and
firms increase their demand for loans, the Fed and private banks
are said to accommodate the demand for credit. Credit is
extended and investment increases, increasing output and
income. Higher income means higher savings, and these
savings are redeposited in the banking system.
endogenous money supplyThis depiction of the money supply
process fits in very nicely with Keynes’s view of the

investment-savings relationship and capitalism as a demand-led
system. Just as Keynes turned the investment-savings relation
on its head, likewise, in this view loans create deposits rather
than the other way round.
Incorporating endogenous money into the Keynesian view of the
investment-savings relation
savings are redeposited into banks, replenishing reserves
depleted initially by the loans and even increasing reserves
Institutional mechanisms banks can use to try to extend their
lending capacity
1. Fed Funds – member banks of the Federal Reserve system can
borrow reserves from one another. These reserves are called
“Fed Funds” and the rate of interest they pay is the Federal
Funds rate, the inter-bank lending rate set by the Fed.
lending capacity
2. Foreign banks – U.S. banks can borrow dollars from foreign
banks, that are not regulated by the Fed and so have no reserve
requirements in dollars. These reserves used to be called
“Eurodollars” but it is no longer only European banks that lend
and the creation of the “Euro” currency makes the terminology
confusing (what would we call the Euros European banks
borrow from abroad, “Euroeuros”?

lending capacity
3. certificates of deposit (CDs) – these are savings accounts that
must keep a minimum balance for a minimum length of time.
The key to understanding how they are used to extend lending
capacity is that the rrr on CDs is lower than on other types of
accounts. Banks can use CDs to extend lending capacity in two
ways:
Using CDs to Extend Lending Capacityi. offer new, attractive
CDs to attract new customers, increasing reserves;ii. change
current customers over from regular deposits, e.g., checking
accounts, to CDs, decreasing the average rrr.
lending capacity
4. Repos (repurchasing agreements) – a repo is, in general, an
agreement between a buyer and a seller to reverse a transaction
at a specified time in the future (often the next day) at a
specified price. So a bank will sell $1 million worth of bonds
today and agree to buy them back tomorrow for $1.01 mil. The
first bank will get to “hold” $1 mil. Overnight, increasing its
average reserve holdings over that period (banks do not have to
meet their reserve requirements at every moment in time, just
on average over a two-week period). The second bank will get
to earn something on its excess reserves.

lending capacity
5. open market operations – selling bonds to obtain reserves,
with or without repos attached.
lending capacity
6. Fed as “Lender of Last Resort” (LLR) – borrow reserves from
the Fed, at the discount rate (rate of interest Fed charges banks
to borrow reserves). This is called going to the “discount
window”. Fed is LLR in the sense that it is the ultimate lender
of dollars, and in the sense that banks use it as the last resort,
because there can be penalties for repeatedly failing to meet
reserve requirements.
money supply and demand, and the equilibrium rate of
interestThe equilibrium rate of interest in Keynes is determined
by the intersection of money supply and money demand
curves.Assume an exogenous money supply for the time being.
Exogenous Money Supply
Money Supply (Ms)
Interest Rate
Quantity of Money
Money Demand (MD)
M*
i*
0

Keynesian Monetary PolicyMonetary policy is the attempt to
affect macroeconomic variables such as aggregate output,
income, employment and the price level through changes in the
money supply and interest rates.Expansionary policy seeks to
expand output and employment; anti-inflationary policy seeks to
control inflation.Assume exogenous money supply for now.
Keynesian Expansionary Monetary Policy (KEMP)
The Fed increases the money supply through its available
mechanisms (rrr, dr, omo). This causes interest rates to fall,
increasing investment, causing output, income, and employment
to expand.
Keynesian Expansionary Monetary Policy (KEMP)
Ms1
Interest Rate
Quantity of Money
MD
Ms2
i*1
i*2
M1
M2
0
Limits of KEMP
Keynesian Expansionary Monetary Policy has three limits.
Interest rates may be insensitive to changes in the money supply

(liquidity trap)
Liquidity Trap – horizontal portion of the money demand
function. When interest rates get so low that no one thinks they
can get any lower, so no matter how much money the Fed
throws into the system, people just hold onto it, waiting for
interest rates to rise and bond prices to fall.
Liquidity Trap
Interest Rate
Quantity of Money
MD
Ms2
iLT
M2
M3
Ms3
0
Liquidity Trap
Limits of KEMP
2. Investment may be insensitive to changes in interest rates
(recall all of Keynes’s’ warnings about inverse, mechanistic
relation between interest rates and investment).
Limits of KEMP
3. Output may be insensitive to changes in investment. (either if
the economy is at full employment—in which case why pursue
expansionary monetary policy—or, if the mpc is falling faster

than investment is increasing.
Keynesian Anti-Inflationary Monetary Policy (KAIMP)
Fed decreases money supply, causing interest rates to rise,
causing investment to slow, decreasing inflation.
(here P↓ is usually a slowing of inflation rather than deflation)
Keynesian Anti-Inflationary Monetary Policy (KAIMP)
Ms1
Interest Rate
Quantity of Money
MD
Ms2
i*1
i*2
M1
M2
0
Limits of KAIMPKeynesian Anti-Inflationary Monetary Policy
has two limits.
1. It is only effective for “demand-pull” inflation—inflation due
to excess demand. If there is “cost-push” (or supply-side)
inflation, it may not be effective and could even exacerbate it
(though higher finance costs, for example).

Limits of KAIMPKeynesian Anti-Inflationary Monetary Policy
has two limits.
2. The Fed can overshoot its mark and the fall in investment
may cause output and employment to fall, which can even cause
a recession.
Keynesian Fiscal and Monetary PoliciesIn general, fiscal policy
is seen as more direct, stronger, and more effective, and
monetary policy is seen as more indirect, weaker, and less
effective.In the Post-War “golden age” of U.S. capitalism
(approximately 1946-1971), a combination of fiscal and
monetary policies were used, called “fine-tuning” the
macroeconomy.
Supply-Side Economics.ppt
Supply-Side Economics
“Reaganomics,” Monetarism, and Military Keynesianism
Cornerstones of Supply-Side Economics in the 1980s
1) supply-side tax cuts for business to provide incentives for
firms to produce, and tax cuts for households to promote the
incentive to work in the labor market

2) Shift in the composition of government spending away from
social programs (including job training and education) to
military spending—but no net decrease in government spending
3) Contraction of the money supply to fight inflation—supply-
siders in the early 1980s accepted the monetarist view of the
quantity theory insofar as there being a direct relation between
M and P.
4) Deregulation of industry and financial institutions—to cut
costs, promote efficiency, and remove cumbersome laws and
regulations.
5) Don’t worry about demand, Say’s Law holds.
Say’s Law—
“supply creates its own demand”
SUPPLY-SIDE ECONOMICS
year GNP deficit tax cuts trade deficit notes
1981 (Ms contracted to fight inflation; i rise 23.5%)
1982 -2.5% $128b 5% $ 38.4 U x 2 to 9.5%
1983 +3.6% $208 10% $ 64.2 9.5% unempl.
1984 +6.0% $185 10% $122.4
1985 +3.3% $212 $133.6

1986 +2.7% $221 $155.1
1987 +3.4% $150 $170.3
1988 +4.4% $155 $137.1
1989 +2.5% $153 $129.4
1990 +1.0% $220 $123.4
1991 -. 7% $269 $ 86.3
supply-side in the 80s1981: Reagan entered office in 1981-
first attacked inflation: anti-inflationary measures are policies
that favor creditors over those in debtmoney supply was sharply
contracted- Supply siders are monetarists when it comes to
monetary policy; both monetarists and supply-siders are
neoclassicals- did bring inflation under control - monetarist
would say because of direct relation between M and P; but what
would Keynes say happens when M supply is contracted?
Interest rates should go up? In fact, interest rates shot up
23.5%!
supply-side in the 80s1982: GNP fell 2.5% as unemployment
nearly doubled until 12 million officially out of work. Reagan
tax cuts begin (5%), and deficits increase by over 64% or $50b
to over $128b. Biggest recession since before WWII (up to that
time).
supply-side in the 80s1983: GNP rises 3.6%, but that is just
1.1% increase in output from two years previous- deficit
expands 62.5% to a whopping $208 billion (almost triple from
when Reagan entered office) as more tax cuts (10%) and trade
deficit rises 67% from $38.4b to 64.2b. No improvement in
unemployment- still 9.5% unemployed.

supply-side in the 80s1984: so-called 'recovery' GNP rises by
6%, but another $185b deficit; and trade deficit up 90% to
$122.4b. Another 10% tax cut leading to another $433b in
deficits in next two years.
Supply-Side EconomicsLogic of Supply-Side Tax Cuts:
-Tax cuts for workers give them an
incentive to work, work harder and work more hours.
- Tax cuts for businesses means firms will
invest and produce more.
Supply-Side Tax Cuts—Workers Problems: After-tax income is
important to workers. But it is only one -- a very important one,
but nevertheless only one -- part of total job satisfaction. Job
security, work environment, many other factors are also
important, as numerous studies have shown. What is happening
to the job security index when unemployment shoots up to
double digits in the Reagan recession? What is happening to the
work environment index when deregulation kicks in?
Moreover, to enjoy the incentive of take home pay, you have to
have some pay to take home, and so these incentives mean
nothing for the unemployed.
Supply-Side Tax Cuts—Firms
As far as businesses, again we go back to Keynes's emphasis on
expected profitability. It doesn't matter if taxes are smaller, if
expectations are dimmed because of a recession and

unemployment, firms aren't going to be increasing productive
capacity. They aren't able to sell all they can produce now. A
capital gains tax cut does nothing to guarantee investment. An
investment tax credit may help a little more, at least then there
is some incentive to invest.
Supply-Siders and Say’s Law
For both these cases, supply doesn't create its own demand.
Supply-siders are adherents to Say's Law, but Say’s law means
production generates income sufficient to purchase that
output—the national income accounting identity—but does not
guarantee that all production will in fact be purchased.
costs and revenues
Lower costs for one is lower income for others—in this case
with the tax cuts, much of that lower income resulted in lower
tax revenues for government—look at what happened to the
budget deficit following the tax cuts.
Reaganomics—the legacy
But then what about the Reagan recovery? From 1982-84 there
were over $520b in deficits—that's fiscal stimulus. The so-
called recovery was demand side, not supply side. One
indicator that this is so is the fact that there was inflation in this
period. See this with AS-AD analysis.
Reagan Recovery—supply or demand side expansion?
P

Y
P*1
Ye*1
0
AD1
AS1
AS2
P*2
Ye*s
If the recovery was supply-driven, then there should be an
increase in output with steady or falling prices. If the expansion
was demand-driven, output and prices would both rise.
P
Y
P*1
Ye*1
0
AD1
AS1
P*2
Ye*s
AD2
Reagan Recovery:

why didn't it last?
1) This was military Keynesianism- the tax cuts combined
with no decrease in G but a shift in the composition of spending
to military expenditures gives us a multiplier effect but a low
one—there is no inner growth dynamic to military spending.
Reagan Recovery:
Why didn't it last?
2) redistribution of income from poor to rich meant
redistribution from those with a higher mpc to those with a
lower mpc—and so a lower multiplier.
Reagan Recovery:
why didn’t it last
3) booming trade deficit—without a full employment policy,
this becomes a problem, because reverse multiplier effect—
declining competitiveness in US manufacturing, refusal to try to
limit capital flight, protect domestic industry
Reaganomics: why didn’t it last?
4) deregulation of the banking system—led to S&L crisis; $500
billion + taxpayer bailout

Reaganomics: problems
5) contrary fiscal and monetary policy—expansionary fiscal,
anti-inflationary monetary…
6) decline in infrastructure and
education/skill level of the labor force
1990-91—Worst recession since WWII up to that time.
End of supply-sideEnd of the supply-side era: $4.2 trillion debt
run-
7.5% unemployment
ClintonomicsWith the run-up of the national debt, Democrats
took a political strategy of trying to call the Republicans
fiscally irresponsible. The Democrats were very upset about
deficit dove positions that said deficits and the debt were ok.
They didn't want to hear that deficits weren't a problem and
maybe they were even good sometimes and we shouldn't fret
over the debt. So that by the end of the eighties, the two parties
are both claiming to be the 'really' fiscally responsible one,
against those terrible deficits and the national debt, and any
common sense that had been represented in the mainstream
policy debate vanishes into thin air.

Reaganomics and “Big Government”
Several Reagan advisors reveal that the Reagan administration
purposely ran up deficits and the debt to try to bankrupt big
government—tax cuts leading to big deficits were the only path
to “downsizing” big government.
“It’s the Economy, Stupid!”
A key part of "It's the Economy Stupid!" Economics is budget
balancing, deficit reduction. The deficit did fall; the budget
even moved into surplus. But that was not the cause of the
Clinton expansion, it was the result of rising incomes and the
automatic stabilizers. By the turn of the century we have Al
Gore running on paying down the debt, surplus uber alles, and
putting money in a “lock-box.” The private sector is racked with
debt, and the U.S. circa 2000-2001 looked more and more like
Japan in the early 90s, where interest rates at zero for years did
nothing to stimulate the economy.
Tweedle-dee and Tweedle-dum
Debates over issues like social security are fraught with
fallacies and misunderstandings concerning the modern money
system and budgetary and employment policy. Republicrats and
Demublicans alike do not understand modern money or
functional finance.
The Neoclassical-Keynesian Synthesis.ppt

The Neoclassical-Keynesian Synthesis
Real Balance Effects and the Neoclassical Response to Keynes
The Neoclassical Response to the Keynesian Critique
Some neoclassical economists became Keynesians
Some tried to ignore Keynes
Some misinterpreted Keynes as arguing that sticky wages and
prices could cause unemployment in the long run (this result
was already in neoclassical economics—if that is all that
Keynes was arguing, then Keynes was not making a new
contribution).
Neoclassical Response to Keynes
4. This next response was the most interesting: it said, “Keynes
is making some real contributions and we should recognize that.
His theory of the multiplier, his argument that we should
conduct aggregate analysis and that money should play a
central, determining role, even his liquidity preference theory,
are all real contributions and should be incorporated into the
analysis.”
Response to Keynes“But,” this response continued, “if Keynes
is saying he is refuting neoclassical theory he is going too far.”
“Because,” they said, “it can be shown that all of these
contributions can be incorporated into the broader neoclassical
framework and it can still be demonstrated that the central
proposition of neoclassical macro theory still holds.”

Central Proposition of Neoclassical MacroThey argued: “It can
still be shown that if wages, prices, and interest rates are
perfectly flexible that the economy will tend to full employment
in the long run.”The argument will look a little different, it
won’t be simply the old neoclassical labor and loanable funds
markets story.
Grand Neoclassical-Keynesian SynthesisThis argument, which
came to be known as the neoclassical synthesis, used the real
balance effects arguments to demonstrate their proposition.The
real balance effects has two parts: the direct real balance effect,
or Pigou effect, and the indirect real balance effect, or Keynes
effect, or interest rate effect.
Real Balance EffectsThe real balance effect argument begins by
noting that in Keynes if there is unemployment, or aggregate
supply is greater than aggregate demand, firms will cut back
production, income will fall, and employment will fall.But, they
ask, what if instead of cutting output, firms cut prices in
response to insufficient demand? And if this occurred
throughout the economy, the price level would fall (there would
be deflation). Deflation means that the real value of money
would rise.
Direct Real Balance
(or Pigou) Effect

When AS>AD, the price level falls, increasing the real value of
money. Consumers and investors holding cash would feel
richer, and consumption and investment would rise. This would
set off multiplier effects, increasing output and income. As
long as AS>AD, this would continue, until full employment.
Indirect Real Balance (or Keynes or Interest Rate) Effect
Demand for Money in Keynes
Keynes asked the question: “Why would anyone hold any of
their wealth in the form of cash rather than in higher interest-
earning or profit-bearing assets?”
He gave three reasons in The General Theory: transactions
demand for cash, precautionary demand for cash and the
speculative demand for cash.
Demand for Money
Transactions demand – wealth people keep in the form of cash
to make normal daily, weekly, and monthly transactions.
Precautionary demand – in case of emergencies (flat tire,
broken arm, etc.)
Speculative demand – in case an unexpected financial
opportunity should arise, to earn higher than normal profits.

inverse relation between bond prices and interest rates
Suppose a bond that sells for $1000 earns $50 per year interest.
So the interest rate is 5%. Then suppose the interest rate rises
to 10%. The bond is locked in to a return of $50 per year, so
the price falls to $500. (think of the alternative of putting $1000
in the bank at 10%, it would earn $100, so no one would buy the
bond for $1000 when the return is $50 if the interest rate is
10%.).
Real balance effects and neoclassical synthesisNotice that the
RBE incorporate aggregate analysis, money as a central
determining variable, the multiplier, and liquidity preference
theory all from Keynes.Yet the central proposition of
neoclassical macro still holds—if wages, prices, and interest
rates are perfectly flexible, the economy tends to full
employment in the long run, no government intervention.
Keynesian reply to RBE
1. yes, if price level falls, real value of $ rises, but what about
the real value of non-cash assets? So, whether you feel richer
or poorer when there is deflation depends on whether
households and businesses keep their wealth in cash or non-cash
assets.
2. yes, if price level falls, real value of $ rises, but what about
the real value of debt? Debt is denominated in cash, so real

value goes up when price level falls. Whether households and
businesses feel richer or poorer when there is deflation depends
on the importance of debt (consumer debt, corporate debt, and
government debt as well).
3. Consideration of expectations complicates the RBE stories.
If consumers and investors do not know if prices and interest
rates will continue to fall, they may not buy (and borrow to
buy), but wait and see if they fall more. And if they do not buy
(and borrow), then prices and interest rates continue to fall.
How high will the real value of debt inflate before they think
prices and interest rates have hit rock bottom?
4. Lower prices may be good for buyers, but are they good for
sellers? It depends. If you are thinking about investing in
producing widgets because interest rates are down, and you see
the prices of widgets falling, there is a limit to how low prices
can go before it is a dis-incentive for you to expand output in
that market.
5. Indirect real balance effect reintroduces the mechanistic
inverse relation between interest rates and investment that
Keynes criticized. (this applies only to the indirect real balance
effect).

6. Historical experience and empirical record
a. Great Depression – deflation, but no real balance
effects. Interest rates zero, no investment.
b. Post WWII experience of industrialized nations. Many
periods of unemployment, but virtually no deflation. (slowing
of inflation not the same as deflation)

Macroeconomics 201 Answer all 25 multiple choice questions..docx

Recommended

Recommended

More Related Content

Similar to Macroeconomics 201 Answer all 25 multiple choice questions..docx

Similar to Macroeconomics 201 Answer all 25 multiple choice questions..docx (16)

More from infantsuk

More from infantsuk (20)

Recently uploaded

Recently uploaded (20)

Macroeconomics 201 Answer all 25 multiple choice questions..docx