Supply side economics/Reaganomics

4-19-17

• Manipulate aggregate supply by enacting policies designed to stimulate incentives to work, save, and invest 
• ex: tax cuts= increase disposable income

Laffer Curve

• Theoretical relation between tax rate and govt revenue

Criticism of laffer curve

• 1- imperial evidence 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
• 3- where the economy is actually located on the curve is difficult to determine 

Phillips curve

Phillips Curve

• Inverse relationship between inflation and unemployment
• trade off
• Each point of the Phillips curve corresponds to a different level of output

Long run Phillip curve

• occurs at natural rate of unemployment
• is represented by a vertical line
• no trade of between unemployment and inflation
• due to economy producing at full employment level
• only shift if LRAS shifts 
• NRU is equal to
• frictional, seasonal, and structural unemployment 

Short Run

• since wages are sticky inflation changes wages moves the point on the LRPC
• If inflation persist and expected rate of inflation rises then the entire SRPG moves upward
• Stagflation- unemployment and inflation simultaneously rises 
• Supply shock- rapid and significant increases in resource cost
• If inflation expectations drop due to new tech or efficiency then SRPC will move downward
• Misery index- combination of unemployment and inflation in any given year
• single digit misery is good

Long run extra

• increase in Un will shift LRPC right
• decrease in Un will shift LRPC left

loanable

Loanable Funds Market

4-3-17

• is interest rate of 50% good or bad
• bad for borrowers but good for lenders
• Loadable funds market is private sector supply and demand of loans
• this market brings together those who want to lend $1(savers) and those who want to borrow(firm with investment spending projects)
• This market shows effect of real interest rate 
• Demand- inverse relationship between real interest rate and quantity loan demanded
• Supply- direct relationship between real interest rate and quantity loans supplied
• supply is not vertical

Federal Funds rate

• interest rate that banks charge one another for overnight loans

Prime rate

• interest rate that the banks charge their credit worthy customers

Loadable Funds Market

4-3-17

Loadable Funds Market 

• IS interest rate of 50% good or bad?
• bad for borrowers but good for lenders
• loadable funds market is private sector supply and demand of loans 
• this market brings together those who want to lend money (savers) and those who want to borrow(firms with investment spending projects)
• this market shows effect of real interest rate
• demand- inverse relationship between real interest rate and quantity loan demanded
• Supply- direct relationship between real interest rate and quantity loans supplied
• supply is not vertical

Federal fund rate

• interest rate that banks charge one another for over night loans

Prime rate

• Interest rate that the banks charge their credit worthy customer

Tools of Monetary Policy

3-31-17

Tools of Monetary Policy

3 tools

1. Setting RR
2. lending $ to banks and thrifts
• Discount rate
3. Open Market Operations
• Buying and selling bonds

RR

• "fractional reserve system"
• The Fed sets the amount that bank must hold
• RR is % of deposit that banks must hold in reserve
• loan eventually becomes deposits for another bank that will loan out ER 
• If there is a recession fed actions on RR
• decrease reserve ratio
• Banks hold decrease money and have more ER
• Banks create more $ by loaning out excess
• money supply increases, interest falls, AD increases, RR decreases, MS increases, i increases, I increases, and AD increases
• If there is inflation fed actions on RR
• Increases reserve ratio
• Banks hold more money and have less excess reserve
• banks create less money
• RR increases, MS decreases, i increases, I decreases, AD increases
• OMO is when fed. buy or sell govt bonds
• this is most important and widely used monetary olicy
• of fed buys bonds it takes bonds out of the eco and replaces them with $
• If fed sell bonds it takes $ and give the security to the investor
• To increase MS fed should BUY govt securities
• to decrease MS fed should sell govt securities
• If fed buys bonds the DD X MM

Discount Rate

• interest rate that fed charges commercial banks for short term loans
• DD generally not used by the fed to affect monetary supply

Money creation formula

3-27-17

Money creation formula

• A single bank can create $ by amount of its ER
• banking system as a whole can create $ by a multiple of excess reserves
• MM X ER = Expansion of $
• Money multiplier= 1/RR

News vs Existing $

• Initial deposit in a bank comes from the FED/bank purchase of a bond or other $ out of circulation (buried treasure), the deposit immediately increases the $ supply
• deposit then leads to further expansion of $ supply through the $ creation process
• Total change in MS if initial deposit is new $ = Deposit + $ created by banking system 
• if deposit in a bank is existing $ (already counted in M1), depositing the amount does NOT change the MS immediately cs it already counted
• Existing currency deposited into a checking account changes only the composition of the $ supply from coins.paper $ to checking account depositing
• total change in the MS if deposit is existing $ = banking system created $ only

Bond and stocks

3-22-17

Bonds and Stocks

• bonds are loans, or IOUs, that represent debt that the govt or corporation must repay to investor
• bond holder has no ownership of company

Bonds

• First if a corporation issues and then sells a bond
• liability or asset is corporation
• assets  or liability are buyers
• If that corporation issues a lok bond with a 10 yr. term and a 5% interest
• nominal interest rate = 5%
• nominal interest falls 3% = value of bond increases
• nominal interest rate rises 8 = value of bond decreases

Stock owners

• earn profit in two ways:
• Dividends, portions of corporations profit are paid out to stock holders
• higher corporate profit, the higher the divided
• Capital gain: earned when stockholders sell stock at lower price than purchase price suffers a capital loss

The money market

• Demand fir $ has inverse relationship between nominal interest rates and quantity of $ demanded
• What happen when demand of $ when in. rates increases?
• Quantity demand falls because of individuals would prefer to have interest earning assets instead of borrowed liabilities
• What happens when quantity demanded when in. rates decreases
• quantity demand increases no incentive to convert cash

Money Demand Shifters

1. Changes in price lvl
2. changes in income
3. changes in taxation that affect investment

• Money demand curve slopes decreases and to the shifts because all else being equal higher interest rates increase the opportunity cost of holding $, thus leading public to reduce quantity of $ it demands

Fractional Reserve system

• Demand deposits/checks
• process by which banks hold a small portion of their deposits in reserves and loan out the excess
• banks keep cash on hand which is (RR) to meet depositor's needs 
• MS only moves by bond or loans