Topics to study for Chapters 12-15

Chapter 12: Fiscal Policy

1. What are the tools that can be used for discretionary fiscal policy?

2. According to the theory of fiscal policy, how could the government stimulate the economy during recession?

3. How can fiscal policy restrict the economy during excessive expansion?

4. What is the value of the simple income multiplier from government spending if the MPC is .8?

5. What is the value of an autonomous tax multiplier if the MPC is .8?

6. Why does stimulative fiscal policy result in higher prices? How does this relate to the slope of the aggregate supply curve?

7. How do automatic stabilizers differ from discretionary fiscal policy tools?

8. In what ways can fiscal policy affect aggregate supply?

9. What factors make it difficult for the government to fine-tune the economy by using fiscal policy?

10. What was the golden age of fiscal policy?

11. How is discretionary fiscal policy affected by consumer response to permanent income?

Chapter 13: Money and the Financial System

1. Why does barter depend on the double coincidence of wants?

2. What are the three important functions of money?

3. Why is the opportunity cost of commodity money higher than for token money?

4. How did goldsmiths develop the first fractional reserve system?

5. Why do people accept fiat money? Under what circumstances might they refuse to accept fiat money?

6. What happens if there is too much money in the economy? What happens if there is not enough money in the economy?

7. Why are wars often associated with inflation? (Hint: relate to how defense spending by the government is finaced.)

8. Why was the Federal Reserve System created?

9. What caused disintermediation of funds during the 1970s? Why did it lead to deregulation of financial markets?

10. Why does deposit insurance by the FDIC effectively eliminate bank panics in this country?

Chapter 14: Banking and the Money Supply

1. What is the primary function of financial intermediaries?

2. What advantages do financial intermediaries have over individual households in making loans or buying other direct securities?

3. Why are the liabilities of financial intermediaries called “indirect securities?”

4. What are the components of M1? Why do economists more frequently refer to M2 when talking about the money supply?

5. How do banks make a profit from their reserves? How does this allow banks to create money?

6. How much from an initial increase in bank reserves can an individual bank safely lend out to create money?

7. How much from an initial increase in bank reserves can the banking system as a whole lend out to create money?

8. How does the money multiplier mathematically to the reserve requirement ratio?

9. What limits could exist to reduce the money multiplier from a given amount of reserves? (Hint: focus on excess reserves and the currency drain.)

10. What are the sources of borrowing by banks to meet reserve requirements? How does it relate to the discount rate and the federal funds rate?

11. How does an open market purchase of U.S. securities directed by the FOMC affect bank reserves and the money supply? What about a sale of U.S. securities directed by the FOMC?

Chapter 15: Monetary Theory and Policy

1. How does the medium of exchange function that money performs affect the demand for money?

2. How does store of value (wealth) function that money performs affect the demand for money versus bonds?

3. What advantage does money have as a store of wealth compared with bonds? What disadvantage?

4. What is meant by the opportunity cost of holding money?

5. What causes a shift in the demand curve for money? What causes a movement along the demand the demand curve for money?

6. Why is the money supply function viewed to be vertical with respect to interest rates? How can it shift?

7. How does the demand for money and supply of money determine the equilibrium interest rate?

8. Describe how an increase in the money supply affects the interest rate, desired spending, aggregate demand, and prices and income according to the indirect channel?

9. How does more money affect spending on GDP according to monetarists (the direct channel)?

10. What is the equation of exchange?

11. How is the velocity of money affected by a change in interest rates according to the indirect channel?

12. Why is the velocity of money viewed to be stable according to the direct channel?

13. If the economy is in long-run equilibrium, what are the short-run and long-run effects of an increase in the money supply? A decrease in the money supply?

14. If more government purchases are made at full employment, why do both the price level and interest rates reduce the value of the multiplier?

15. If nominal GDP is $100 billion and the velocity of money is 4, what is the quantity of money in the economy?

16. How can the equation of exchange, which is an identity, be developed as a theory between money growth and future money income.

17. Why is the velocity of M2 more stable than the velocity of M1?

18. Why can’t the Fed control both the money supply and the interest rate simultaneously?