HOMEWORK 7

Explain how money is created. Compare the tools of the Federal Reserve System

K

·         In economics, money creation is the process by which the money supply of a country or a monetary region (such as theEurozone) is increased. A central bank may introduce new money into the economy (termed 'expansionary monetary policy') by purchasing financial assets or lending money to financial institutions. Commercial bank lending also creates money under the form of demand deposits). When banks had sizable reserve requirements (freezing an important percentage of their deposits in mandatory reserves at the central bank) it was said that the process multiplied this base money through fractional reserve banking.

·         Central banks monitor the amount of money in the economy by measuring monetary aggregates such as M2. The effect of monetary policy on the money supply is indicated by comparing these measurements on various dates

·         The Fed funds rate is perhaps the most well-known Federal Reserve tool. However, it has many more at its disposal, and they all work together. Here's an introduction to them all, with links if you want to read more. the has several other tools which allow it to set monetary policy.

·         If a bank doesn't have enough on hand to meet the reserve requirement, it will borrow from other banks. The Federal funds rate is the interest banks charge each other for these overnight loans. The amount lent and borrowed is known as the Fed funds. The Federal Open Market Committee (FOMC) targets a specific level for the Fed funds rate at its regularly scheduled meetings.

W

·         How exactly does the Fed go about accomplishing its goals?

·         What tools does the Fed have at its disposal to affect monetary policy?

·         How are bank deposits are created

L

·         The Federal Reserve is responsible for setting the reserve requirements for banks. Reserve requirements specify what percentage of a bank’s deposits the bank has to keep on reserve with the Fed. For instance, if the Fed sets the reserve requirement at 10 percent and a bank has $10 billion in deposits, the bank is required to keep $1 billion on reserve at the Fed

·         The process in which banks increase the amount of funds in checkable deposits (and thus the M1 money supply) by using reserves to make loans. Money creation is made possible through fractional-reserve banking. Because banks keep only a fraction of deposits as reserves, extra reserves can be used to back up and create additional checkable deposits (money) that did not previously exist. Government policy makers (the Federal Reserve System) rely on the money creation process when conducting monetary policy. Money creation by banks is a modern alternative to printing paper currency

Compare and Contrast economic theories: Keynesian, Monetarism, Rational expectations, and Supply Side Economics

K

·         An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed by the British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression. Keynes advocated increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Depression. Subsequently, the term “Keynesian economics” was used to refer to the concept that optimal economic performance could be achieved – and economic slumps prevented – by influencing aggregate demand through activist stabilization and economic intervention policies by the government. Keynesian economics is considered to be a “demand-side” theory that focuses on changes in the economy over the short run.

·         Monetarism is a school of economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over longer periods and that objectives of monetary policy are best met by targeting the growth rate of the money supply.

·         An economic idea that the people in the economy make choices based on their rational outlook, available information and past experiences. The theory suggests that the current expectations in the economy are equivalent to what the future state of the economy will be. This contrasts the idea that government policy influences the decisions of people in the economy.

·         Supply side economics is the economic theory that believes that if taxes are reduced for businesses and the wealthy that the benefits of this will affect everyone. This is also known as trickle down economics.

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·         How is each theory applied and used in modern economics?

·         How does the trickle down policy effect the economy?

·         What is each theory like?

·         What can they be compared to?

·         How can we regulate market economy?

L

·         Supply-side economics is better known to some as "Reaganomics," or the "trickle-down" policy espoused by 40th U.S. President Ronald Reagan. He popularized the controversial idea that greater tax cuts for investors and entrepreneurs provide incentives to save and invest, and produce economic benefits that trickle down into the overall economy. In this article, we summarize the basic theory behind supply-side economics.

·          In The General Theory ofEmployment, Interest and Money  (1936) he argued that unemployment was characteristic of anunregulated market economy and therefore to achieve a high level of employment it was necessary forgovernments to manipulate the overall level of demand through monetary and fiscal policies (including,when appropriate, deficit financing). He helped to found the International Monetary Fund and the WorldBank

The historical perspective of inflation and unemployment in relation to Phillips curve and stagflation.

K

·         In economics, the Phillips curve is a historical inverse relationship between rates of unemployment and corresponding rates of inflation that result in an economy. Stated simply, decreased unemployment, (i.e., increased levels of employment) in an economy will correlate with higher rates of inflation.

·         While there is a short run tradeoff between unemployment and inflation, it has not been observed in the long run.^[1] Accordingly, the Phillips curve is now seen as too simplistic, with the unemployment rate supplanted by more accurate predictors of inflation based on velocity of money supply measures such as the MZM ("money zero maturity") velocity,^[2] which is affected by unemployment in the short but not the long term.^[3]

·         William Phillips, a New Zealand born economist, wrote a paper in 1958 titled The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957, which was published in the quarterly journal Economica. In the paper Phillips describes how he observed an inverse relationship between money wage changes and unemployment in the British economy over the period examined. Similar patterns were found in other countries and in 1960 Paul Samuelson and Robert Solow took Phillips' work and made explicit the link between inflation and unemployment: when inflation was high, unemployment was low, and vice-versa

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·         What are the dynamics of the Phillips curve?

·         What can it be compared to?

·         How can the wages and unemployment be further explained?

·         How does unemployment effect microeconomics?

L

·         The Phillips curve originated out of analysis comparing money wage growth with unemployment. The findings of A.W. Phillips in The Relationship between Unemployment and the Rate of Change of Money Wages in the United Kingdom 1861–1957 suggested there was an inverse correlation between the rate of change in money wages and  unemployment. For example a rise in unemployment was associated with declining wage growth and vice versa.

·         The Phillips curve suggests there is an inverse relationship between inflation and unemployment.

·         Phillips' discovery appears to be intuitive. When unemployment is high, many people are seeking jobs, so employers have no need to offer high wages. It's another way of saying that high levels of unemployment result in low levels of wage inflation. Likewise, the reverse would also seem to be intuitive. When unemployment rates are low, there are fewer people seeking jobs. Employers looking to hire need to raise wages in order to attract employees. (For more insight, read Macroeconomic Analysis.)