Econ Ch 15 A capital loss is a decrease in the value of an asset Opposite for capital gain A realized capital loss is the loss that occurs when the owner of an asset actually sells it for less than he or she paid for it Opposite for realized capital gain The Standard and Poor s 500 S P 500 is an index based on the stock prices of the largest 500 firms traded on the New York Stock Exchange the NASDAQ Stock Market and the American Stock Exchange From a macroeconomic perspective the best stock market index is S P 500 The Fed could tighten monetary policy in a timely manner to moderate the swing in the business cycle When stock market prices are increasing consumers may spend more than they otherwise might have because their wealth is increasing A bond is a document that formally promises to pay back a loan under specified terms usually over a specific time period A stock is a certificate that certifies ownership of a certain portion of a firm The Dow Jones Industrial Average is an index based on the stock prices of 30 actively traded large companies It is the oldest and most widely followed index of stock market performance The NASDAQ Composite is an index based on the stock prices of over 5000 companies traded on the NASDAQ Stock Market As the economy contracts the government deficit grows firm profits decrease decreasing tax revenues transfer payments increase increasing government spending The objectives of stabilization policy are consistent with the overarching goals of monetary and fiscal policy sustainable growth full employment and stable prices Various kinds of time lags or delays in the response of the economy to stabilization policies can make the economy difficult to control Milton Friedman likens government stabilization policy to the fool in the shower He argues that stabilization policy stimulates or contracts the economy at the wrong time Tax laws and spending programs are decided on an annual basis If it becomes clear that the economy is entering a recession in the middle of the year there is little that can be done Monetary policy works by changing interest rates which then changes planned investment and to some degree consumption spending The response to interest rate changes however takes time When conducting monetary policy policy makers must consider response lags most carefully The spending multiplier must effectively be zero so that a decrease in government spending will not cause a negative shift in aggregate demand On implausible argument is that deficit reductions will make firms and consumers more optimistic and they will therefore invest and consume more The contraction induced decrease in tax revenues and increase in transfer payments tend to reduce the fall in after tax income and consumer spending due to the negative demand shock Thus the decrease in aggregate output income caused by the negative demand shock is lessened by the growth of the deficit Negative demand shock is something that causes a negative shift in consumption or investment schedules or that leads to a decrease in US exports Automatic destabilizers refer to revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to destabilize GDP Automatic stabilizers are revenue and expenditure items in the federal budget that automatically change with the economy in such a way as to stabilize GDP Deficit targeting reinforces rather than counteracts the shock that started the recession Big drops in stock market values will have large effects on the wealth of households in these countries Consumers in these countries are therefore likely to spend less dropping consumption and eventually reducing output Recessions are likely to result d The spending cut must induce firms and consumers to invest and consume more Fluctuations in household wealth are frequently due to fluctuations in stock prices and housing prices Stabilization policy describes both monetary and fiscal policy the goals of which are to smooth out fluctuations in output and employment and to keep prices as stable as possible Time lags are delays in the economy s response to stabilization policies They present a major problem when trying to implement monetary and fiscal policy Recognition lag refers to the time it takes for policy makers to recognize the existence of a boom or a slump Implementation lag is the time it takes to put the desired policy into effect once economists and policy makers recognize that the economy is in a boom or a slump The implementation lag for monetary is generally much shorter than that for fiscal policies Response lag is the time it takes for the economy to adjust to the new conditions after a new policy is implemented the lag that occurs because of the operation of the economy itself Gramm Rudman Hollings Bill passed in 1986 under Reagan is a law that set out to reduce the federal deficit by 36 billion year with a deficit of zero slated for 1991 Deficit tend to rise when GDP falls and vice versa Deficit response index is the amount by which the deficit changes with a 1 change in GDP