Unit 7

Formulas

• Balance of Trade:
  Goods Exports + Goods Imports
• Balance on goods and services:
  Goods Exports + Service Exports + Goods Imports + Service Imports
• Current Account:
  Balance on goods and services + Net Investment + Net Transfers
• Capital Account:
  Foreign Purchases + Domestic Purchases

Unit 7

Balance of Payment Chart

	Assets (+) Demand for the $ "Inflows"	Debits/Liabilities (-) Supply of the $ "Outflows"
Current Accounts (CA)
Balance on Goods & Services Net Exports (Xn) Balance of Trade	Exports Tourism here	Imports Tourism there
Net Investment	Interest/dividend payments foreigner paid to the U.S. for use of exported capital.	Interest/dividend payments the U.S. made for use of foreign capital invested in the U.S.
Net Transfers	Aid to the U.S. Transfers back to the U.S. Our royalties	Aid to them Remittances from the U.S. Their royalties
Financial Accounts (K) or (KA) -or- "Financial and Capital Accounts" -or-     "Capital Accounts"	Capital inflows Direct investment in the U.S by  foreigners Purchases of stocks and bonds by foreigners.	Capital outflows Direct investment by the U.S. over there Purchases of stocks and bonds by the U.S.
Official Reserves or Official Settlements or Special Drawing Rights	Currencies IMF holdings Gold	Currencies IMF holdings Gold

Unit 7

The Balance of Payment

• Balance of Payment
• Measure of money inflows and outflows between the united States and the Rest of the World (ROW).
• Inflows are referred to as CREDITS.
• Outflows are referred to as DEBITS.
• The Balance Payments is divided into 3 accounts
• Current Account
• Capital/Financial Account
• Official Reserves Account
• Current Account
• Balance of Trade or Net Exports
• Exports of Goods/Services - Imports of Goods/Services
• Exports create a credit to the balance of payments.
• Imports create a debit to the balance of payments.
• Net Foreign Income
• Income earned by U.S. owned foreign assets - Income paid to foreign held U.S. assets
• Ex. Interest Payments on U.S. owned Brazilian bonds - Interest payments on German owned U.S. Treasury bonds.
• Net Transfers (tend to be unilateral)
• Foreign Aid → a debit to the current account
• Ex. Mexican migrant workers send money to family in Mexico.
• Capital/Financial Account
• The balance of capital ownership
• Includes the purchase of both real and financial assets.
• Direct investment by U.S. firms/individuals in a foreign country are debits to the capital account.
• Purchase of foreign financial assets represents a debit to the capital account.
• Purchase of domestic financial assets by foreigners represents a credit to the capital account.
• Relationship between Current and Capital Account
• The Current Account and Capital Account should zero each other out.
• That is...If the Current Account has a negative balance (deficit), then the Capital Account should then have a positive balance (surplus)
• Official Reserves
• The foreign currency holdings of the United States Federal Reserve System.
• When there is a balance of payments surplus, the Fed accumulates foreign currency and debits the balance of payments.
• When there is a balance of payments deficit the Fed depletes its reserves of foreign currency and credits the balance of payments.
• Where there's a balance of payments the Fed depletes
• Active v. Passive Official Reserves
• The United States is passive in its use of official reserves. It does not seek to manipulate the dollar exchange rate.

Unit 6

Economic Growth & Productivity

• Economic Growth Defined
• Sustained increase in Real GDP over time.
• Sustained increase in Real GDP per Capita over time.
• Why Grow?
• Growth leads to greater prosperity for society.
• Lessens the burden of scarcity.
• Increases the general level of well-being.
• Conditions for Growth
• Rule of Law
• Sound Legal and Economic Institutions
• Economic Freedom
• Respect for Private Property
• Political & Economic Stability
• Low Inflationary Expectations
• Willingness to sacrifice current consumption in order to grow
• Saving
• Trade
• Physical Capital
• Tools, machinery, factories, infrastructure
• Physical Capital is the product of investment
• Investment is sensitive to interest rates and expected rates of return.
• It takes capital to make capital.
• Capital must be maintained.
• Technology & Productivity
• Research and development, innovation and invention yield increases in available technology.
• More technology in the hands of workers increases productivity.
• Productivity is output per worker.
• More Productivity = Economic Growth
• Human Capital
• People are a country's most important resource. Therefore human capital must be developed.
• Education
• Economic Freedom
• The right to acquire private property
• Incentives
• Clean Water
• Stable Food Supply
• Access to technology
• Hindrances to Growth
• Economic and Political Instability
• High inflationary expectations
• Absence of the rule of law
• Diminished Private Property Rights
• Negative Incentives
• The welfare state
• Lack of Savings
• Excess current consumption
• Failure to maintain existing capital
• Crowding Out of Investment
• Government deficits and debt increasing long term interest rates
• Increased income inequality → Populist policies
• Restriction on Free International Trade

Unit 5

Supply Side Economics

Changes inAS and not AD are the main active force in determining the level of inflation, unemployment rates, and economic growth.

• Supply side Economist: support policies that promote GDP growth by arguing that high marginal tax rates along with the current system of transfer payments such as: unemployment compensation or welfare programs provide disincentives to work, invest, innovate, and undertake entrepreneur ventures.
• Incentive to Save & Invest
1. High marginal tax rates reduce the rewards for saving and investment.
2. Consumption might increase but investments depend upon savings.
3. Lower marginal tax rates encourage saving and investment.

Laffer Curve

• A theoretical relationship between tax rates and tax revenues.
• As tax rate increase from zero, tax revenue increase from zero to some maximum level and then decline.
• 3 Criticisms
1. Evidences suggest that the impact of tax rates on incentives to work, save, and invest are small.
2. Tax cuts also increase demand which can fuel inflation, and demand may exceed supply.
3. Where the economy is actually located on the curve is difficult to determine.

Unit 5

Misery Index

• A combination of inflation and unemployment in any given year. Single digit misery is good.
• Supply Shocks: rapid and significant increase in resource cost.
• Disinflation: reduction and inflation fro year to year. Found in the LRPC.
• Deflation: general decline in prices.
• Inflation: general rise in prices.
• Stagflation: unemployment and inflation rise/increase at the same time.

Unit 5

The Phillips Curve

• The Long-Run Phillips Curve: measure of inflation and unemployment. Natural rate of unemployment is held constant.
  
• Because the LRPC exists at the natural rate of unemployment (U_N), structural changes in the economy that affects U_N will also cause the LRPC to shift.
• Increase in U_N will shift LRPC →
• Decrease in U_N will shift LRPC ←
• Relating Phillips Curve to AS/AD
• Changes in the AS/AD model can also be seen in the Phillips Curve.

Long Run

• Occurs at the natural rate of unemployment.
• Always represented by a vertical line.
• There is no trade off between unemployment and inflation.
• If the NRU changes so does the LRPC
• NRU = Frictional + Structural + Seasonal Unemployment
  (4-5%)
• The major LRPC assumption is that more worker benefits create higher natural rates and a few worker benefits create lower natural rates.

Unit 5

Short Run Aggregate Supply

The period in which wages (and other input prices) remain fixed as price level increases or decreases.

• Effects over Short Run
• In the short run, price level changes allow for companies to exceed normal outputs and hire more workers because profits and increasing while wages remain constant.
• In the long run, wages will adjust to the price level and previous output levels will adjust accordingly.

Equilibrium in the Extended Model

• The Long AD Curve is represented with a vertical line.

Demand Pull Inflation in the AS Model

• Demand-Pull: prices increase based on increase in aggregate demand.
• In the short run, demand pull will drive up prices, and increase production.
• In the long run, increases in aggregate demand will eventually return to previous levels.

Cost Push and the Extended Model

• Cost-Push arises from factors that will increase per unit cost such as increase in the price of key resource.

Dilemma for the Government

• In an effort to fight cost-push, the government can react in two different ways.
• Action such as spending by the government could begin an inflationary spiral.
• No action however could lead to recession by keeping production and employments levels declining.

Unit 4

What Banks Do

• A bank is a financial intermediary
• Uses liquid assets (i. e. bank deposits) to finance the investments of borrowers.
• Process is known as Fractional Reserve Banking
• A system in which depository institutions hold liquid assets less than the amount of deposits.
• Can take the form of:
1. Currency in bank vaults
2. Bank Reserves: deposits held at the Federal Reserve
• Basic Accounting Review
• T-Account (Balance Sheet)
• Statements of assets and liabilities
  
• Assets (Amounts owned)
• Items to which a bank holds legal claim
• The uses of funds by financial intermediates
• Liabilities (Amounts owed)
• The legal claims against a bank
• The sources of funds for financial intermediaries
• Function of the FED
1. Issues paper currency
2. Sets reserve requirements and hold reserves of the bank
3. Lends money to the banks and charges them interest
4. They are a check clearing service for bank
5. They act as a personal bank for the government
6. They supervise number of banks
7. They control the money supply in the economy

Unit 4

• When a customer deposits cash or withdraws cash from their demand deposit account, it has no effect on the money supply.
  It only changes:
1. The composition of money
2. Excess Reserves
3. Required Reserves
• Single Bank
• Loan from your excess reserves
• Banking System
• ER x multiplier
  Total money supply
• FED
• When the FED buys or sells bonds, ER is created.

Unit 4

Counter-cyclical Policies: Keynesian Fiscal Policy vs. Monetary Policy

In the early 21^st Century, here in the USA:

An efficient, "full employment" economy will probably have:

1. An annual unemployment rate of 4-5%.
2. An annual inflation rate of 2-3%.


If the economy goes into recession:
3. The real GDP will decrease for at least 6 months.
4. The unemployment rate will go to 6% or more.
5. The inflation rate will probably go to 2% or less.


If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the recession, then:
6. The policy will try to improve C, or G (parts of AD).
7. Congress will decrease federal taxes.
8. Congress will increase job and spending programs.
9. The federal budget will probably create a deficit.
10. Due to changes in Money Demand, interest rates will increase.
    (Crowding out might occur, but Keynesians don't care.)


If the Federal Reserve employs Monetary Policy options to slow/stop the recession, then:
11. The policy will target improvement in Ig (part of AD).
12. The Fed will target a lower federal fund rate.
13. The Fed can lower the discount rate.
14. The Fed can buy bonds (Open Market Operations).
15. The Fed can (theoretically) lower the reserve requirement, but probably won't because it is too complex for the banks.
16. These Fed policies will lower the interest rates through changes in the Money Supply.
17. These options should increase Ig.


If the economy suffers from too much demand-pull inflation or cost-push inflation, then:
18. The unemployment rate will go to 4% or less.
19. The inflation rate will probably go to 4% or more.


If Congress enacts Keynesian Fiscal Policies to attempt to slow/stop the inflation problems, then:
20. The policy will try to decrease C, or G (parts of AD)
21. Congress will increase federal taxes.
22. Congress will decrease job and spending programs.
23. The federal budget will probably create a surplus.
24. Due to changes in Money Demand, interest rates will decrease.


If the Federal Reserve employs Monetary Policy options to slow/stop the inflation problems, then:
25. The policy will target decreases in Ig (parts of AD).
26. The Fed will target a higher federal funds rate.
27. The Fed can increase discount rate.
28. The Fed can sell bonds (Open market Operations).
29. The Fed can (theoretically) raise the reserve requirement, but probably won't because it is too complex for the banks.
30. These Fed policies will increase the interest rates through changes in the Money Supply.
31. Thes options should decrease Ig.

Unit 4

1. The Reserve Requirement
• Only a small percent of your bank deposit is in the safe. The rest of your money has been loaned out. This is called "Fraction Reserve Banking."
• The FED sets the amount that banks must hold.
• The reserve requirement (reserve ratio) is the percent of deposits that banks must hold in reserve and NOT loan out.
1. If there is a recession, what should the FED do to the reserve requirement?
• Decrease the Reserve Ratio
1. Banks hold less money and have more excess reserves.
2. Banks create more money by loaning out excess.
3. Money supply increases, interest rate fall, AD goes up
2. If there is inflation, what should the FED do to the reserve requirement?
• Increase the Reserve Ratio
1. Banks hold more money and have less excess reserves.
2. Banks create less money by loaning out.
3. Money supply decreases, interest rate rise, AD goes down.
2. The Discount Rate
• The Discount Rate is the interest rate that the FED charges commercial banks.
• To increase the money supply, the FED should decrease the Discount Rate (Easy Money Policy)
• To decrease the money supply, the FED should increase the Discount Rate (Tight Money Policy)
3. Open Market Operations
• The FED buys/sells government bonds (securities)
• This is the most important and widely used monetary policy
• To increase the money supply, the FED should buy government securities.
• To decrease the money supply, the FED should sell government securities.

	Easy Money	Tight Money
Monetary Policy	Expansionary	Contractionary
Open Market Operation	Buy bonds	Sell bonds
Discount Rate	Decrease	Increase
Reserve Requirement	Decrease	Increase

Federal Funds Rate: this is where FDIC member banks loan each other overnight funds.

Prime Rate: the interest rate that banks charge their most credit and worthy customer.