UW-Madison ECON 102 - Econ 102 Review (5 pages)

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Econ 102 Review



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Econ 102 Review

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Overview of Professor Eudey's Office Hour Lecture for the Final Exam


Pages:
5
School:
University of Wisconsin, Madison
Course:
Econ 102 - Principles of Macroeconomics
Unformatted text preview:

What the FED did during the Great Recession 1 Direct lending to housing markets They did so bypassed the banks to avoid pushing on a string or bunching up of reserves The federal funds rate was 0 at the time so the banks only lent to each other Our interest rate stayed high The FED lent to houses to lower that interest rate so investment GDP could increase 2 They paid interest on reserves They did so to avoid pushing on a string Kept the banks solvent and did not hurt tax payers 3 They purchased long term debt to invest in the capital stock They also purchased mortgage backed securities and lowered the discount rate Ways the FED could increase the money supply Open market purchases Decrease the federal funds rate Decrease the discount rate Decrease the required reserve ratio Must watch out for a liquidity trap interest rates too low they can t go any lower We may be in one now Seen by the excess reserves a federal funds rate of 0 and the cost of borrowing barely covering inflation PRO S AND CON S TO MONETARY AND FISCAL POLICY Monetary Policy Long Run leads to inflation no change in output gdp labor Only higher P s Short Run effective in changing interest and investment rates Fiscal Policy Long Run Crowding out of investment due to increase in interest rates Crowding out of NX and C as the government spends our dollar appreciates and C and NX fall Short Run No room for it Doesn t work because of lags M1 Currency 46 Checking Deposits Travelers Checks Demand Deposits m2 Savings Deposits 64 M1 Small Time Deposits Money Market Funds Two things the FED does for the Banks Holds Reserves Oversee s check clearing List two factors that were major contributors to the onset of the Great Recession Bank Deregulation Formation of securities that linked housing markets globally Policy that encouraged homeownership Burst of the Housing Bubble Equation for reserve ration Required Reserves Any Excess Reserves Deposits EX 15 000 10 000 50 000 50 Reserve Ratio Notes from office hours Investment banks were the ones who securitized Idea is that they re diverse so if one looses the others win all will be okay Enormous amount of wealth They used to be restricted regionally now they were deregulated so they could be riskier Securitization pooling and repackaging loans that were unrelated Now that s not true because the securities were all linked Investment banks didn t really care about the riskiness They encouraged people to buy even though they knew it was crappy Cheated the customer Credit Default Swaps loans on the security AIG gave them out and never thought they d have to pay for them AIG believed markets were regional Didn t think there would be a national downfall Thought they were diversified enough AIG wasn t required to hold reserves so they couldn t back it up when they failed Increase in defense spending crowding out interest rates increase Increase in transactions demand for money Interest rates go up investment fall output falls wages fall AS will shift because there s no capital deepening Our assets look less attractive to foreigners don t demand as many dollars dollar gets cheaper helps our exporters Our currency is cheaper so C and NX go up Why are banks part of economic infrastructure 1 allocates savings to firms affects capital deepening 2 Banks affect inflation through the money multiplier FED buys bonds somebody somewhere has more money Money Multiplier Increases the ability to spend If banks do make the loans the money supply can multiply Turns a bond into something more liquid helps economy Banking Bailout Great Recession Banks rescued by the government because they made all these risky loans That rescue gave us HUGE government debt If we hadn t rescued the banks Deposit Insurance would ve forced us to pay people who deposited back So even if they did nothing they d have to pay ppl back because of Fed Deposit Insurance Expensive Either way Moral Hazard if something really bad ever happens again they ll be bailed out again Bad incentive Stabilization If we were to use classical think fiscal policy distorts economy possibility of long run affecting capital deepening No short run benefit Classical don t worry about monetary policy because it can t harm Keynes like monetary policy because its neutral and doesn t distort but they DO like fiscal BOTH AGREE 1 Had to have bailed out the banks in a recession 2 Agree on necessary education funding 3 Both like monetary policy better Disagree on amounts how much Temporary cyclical stuff Still affected by great recession Debt still enormous Tax increases back to normal seem HUGE because they ve been low for so long Willingness to pay taxes has been affected Strengths and Weaknesses Monetary Policy No inside lags very quick Decide quick Strength Neutral in long run doesn t distort economy besides a little inflation inflation is fine if all nominal wages adjust with it Disadvantage pushing on a string Fiscal Policy Keynes think we can just hire people to affect AD Works in short run Weakness Long inside lags Long run distorting affect on investment and possibly capital stock crowding out QE like an open market purchase only those are short term QE is long term 10 year 30 year Do so to affect capital stock They try to avoid doing so Pushing on a string caused by 1 banks sitting on reserves 2 a liquidity trap None of these matter if we re trying to REDUCE AD That s easy Money market If price falls transaction demand for money falls Md shifts down Lower REAL interest rate We don t know whats happening to NOMINAL interest rate Interest Rate Effect Say s Law summarizes classical model Supply creates demand People refer to all rates of return as interest rates Its hard to see expectations when buying bonds stocks Easy to look at interest rate Graphs Know increase and decrease in money supply Know the three graphs Monetary policy Board of Governors Officals nominated by pres approved by congress 14 year terms Do policy analysis FOMC consists of Board of Gov plus rotating heads of 12 federal banks Know securitization and credit default swaps a derivative Recognize words about what caused great recessions mortgage backed security Know a DERIVATIVE Why did the FED include Mortgage Backed Securities in their assets They thought that market was dead Did so to increase the liquidity of that Fed sells bonds at Christmas time Do it to slow down GDP or inflation Too much borrowing going on like housing bubble in California Credit card gift card debit card NONE


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