USC ECON 205 - Economic Growth and Monetary Policy I

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ECON 205 2nd Edition Lecture 10 Outline of Last Lecture I. Capital and assetsII. Effect of interest rate and rate of returnIII. Time and RisksI. ProfitOutline of Current LectureI. Economic growth and developmentII. Bilal Khan’s lecture: Economic Convergence of Pakistan with the United States (in terms of GDP per capita)III. Federal Reserve and Monetary PolicyIV. Monetarism and Bank ReservesV. The Stock MarketCurrent LectureI. Economic growth and developmentEconomic Development is the most important subject of macroeconomics. While in high academia they mean different things, economic development—also called economic growth—isthe essence of macroeconomicsThere is a difference between the growth of the GDP and the growth of per capita income. The growth of the GDP refers to the growth of the whole economy and therefore usually grows over time. However, the growth of per capita income has to do with the income of each individual in a country.II. Bilal Khan’s lecture: Economic Convergence of Pakistan with the United States (in terms of GDP per capita)The real GDP per capita in the United States has risen from under $5000 in 1950 to over $45,000 in 2010; however, Pakistan’s has risen from nearly $0 in 1950 to a bit under $5000 in 2010. US GDP growth is around 2.5%, while Pakistan’s is about 4%. Therefore, the real GDP ratioper capita between Pakistan and the United States has been approximately 5%.Using math and statistical models, we have determined that the convergence year of Pakistan’s and the US’s real GDP per capita will be in 2645 AD. However, the growth rate for a nation like Pakistan may be stopped or reversed are the current energy crisis, a volatile securitysituation, past military interventions, and corruption in state institutions. The per capita convergence is only true if ceterus paribus holds.III. Federal Reserve and Monetary Policy The Federal Reserve System consists of twelve banks that regulate the monetary supply of the United States. It has one major office in Washington, the Board of Government, with six members plus a chairman. They are appointed for 14 years.The functions of the Fed are: federal open market committee, bank reserve requirements, discount rates—federal fund rates (short term rates versus long term rates), selective controls, and moral suasion.The liquidity trap is when the Federal Reserve’s interest rates are near or at zero. At thatpoint, monetary policies are ineffective since it cannot go lowerTo predict the effect of money supply on the economy, the Fed uses the quantity theory of money: MV = PT(Q)- MV is the money velocity, P is the price level, and T is the price of transaction. Ergo, P = PQ/M. If you increase the amount of money in supply, the price level will go up. IV. Monetarism and Bank ReservesMonetarism is the view that money supply should increase at a low fixed rate, with no mini-managing of the money supply. It is the Chicago School, having been developed by Milton Friedman at the University of Chicago. It states that the government should increase the amount of money by a small increment each year, instead of changing it hugely like we do now.Bank reserves are the cash in their vaults plus the deposit with the Federal Reserve Bank. Fractional reserve banking depends on bank reserves being only a fraction of what was deposited; the reserves are less than 100% of the original deposit. Ergo, bank money is equal to the total reserves multiplied by the reciprocal of the reserve ratio.V. The Stock Market:The stock market is divided into many categories, like growth stocks, blue chips, defensive stocks, and cyclical stocks. Growth stocks are stocks that appreciate over time, creating capital gains. They are usually in the new technological industries. Blue chip stocks, however, are reputable companies that pay out regular dividends. Defensive stocks are very stable stocks that do not change much, however money is earned through dividends (utility companies, for instance, are defensive stocks). Lastly, cyclical stocks are stocks that are very affected by ups anddowns in the economy. Professor Irving Fisher, who famously predicted the economic boom of the ‘20s would never die down, lost most of his wealth in the stock market in the crash of

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