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Macrotheory Final

Terms in this set (54)

store of value
The use of money to save up for the future would be an example of money's role as a
store of value
Double coincidence of wants
two economic agents want to exchange the goods they have
The cash-in-advance assumption means
some goods require currency to be purchased
The current demand for money increases when
the nominal rate of interest decrease
The money supply is vertical because
the money supply is set by policy
Open Market Operation
When the Federal Reserve buys Treasury bonds
Money is neutral
If an increase in the level of money supply leads to a poportionate increase in prices with no effect on real variables
in increase in the real interest rate and an increase in prices
In the intertemporal model, the effects of a temporary decrease in total factor productivity include
Examples of increasing the money demand
disruptions in the banking system, possibility of a bank run, a change in the perceived riskiness of banking (increase in risks), possibility that banks could fail, changes to the hr-to-hr /week-to-week changes

(Anything that causes the consumer to want more money in their hands)
Examples of a decrease in money demand
introduction of online banking
wider availability of ATMs
the introduction of deposit insurance
new information technologies
change in gov. regulations
new financial instruments that lower the cost of banking
Money supply targeting has been abandoned b/c
it leads to price instability in the face of real shocks
The behavior of the Solow residual suggest that when current total factor productivity increases
such increases are temporary, so we can draw no conclusions about the likely behavior of future total factor productivity
The basic real business cycle model has some difficulty explaining why
the money supply is procyclical
The real business cycle model best explains the procyclicalilty of the nominal money supply by
endogenous money
An important critique of the real business cycle theory is the belief that cyclical movements in total factor productivity
may, in part, be an artifact of measurement error
The segmented markets model is motivated by the fact that
not everyone participates in financial markets
What is money
medium of exchange, store of value, unit of account
medium of exchange
money is accepted in exchange for goods/services
store of value
allows consumers to trade current goods for future goods
unit of account
all contracts are demominated in money
i.e. all U.S. firms keep their books in terms of money
When does neutrality of money occur?
when a one-time change in the money supply has no real consequences for the economy (doesn't affect real variables--consumption, investment, output, employment, real interest rate, economic welfare)
Reasons why money is important to economics:
1- Economy functions better with money than without it.
2- changes in the quantity of money in existence matter for nominal quantities
The monetary intertemporal model, is what type of a model
cash-in-advance model
What is a cash-in-advance model?
When cash is used for an exchange
(money is useful in transactions & is more sophisticated)
What is the nominal interest rate
rate of return in units of money (or nominal terms)
A level increase in the money supply occurs when
a level increase in the money supply increases the price level & the nominal wage in proportion to the increase in money supply, but has no effect on any real macroeconomic variable
Types of level increases in money supply
Friedman's helicopter drop, open market operation, seignorage
What is Friedman's helicopter drop
the government reduces taxes for everybody as a way of increasing money supply (is like a government helicopter flying over the countryside spewing money)
What is Seignorage
occurs when government spending increases (printing money to finance government expenditures)
What are the targets & rules of monetary policy?
Shocks the central bank is concerned with ( shifts in money demand, shifts in output demand, shifts in output supply)
Alternative policy rules (money supply targeting & interest rate targeting)
If the central bank wishes to stabilize the price level what is the inflation target rate?
∏* = 0
Does interest rate targeting achieve price stability in the face of shocks?
money demand shocks - YES (increasing Md, increases Ms which keeps P & r constant)

output demand shocks - NO (interest rate targeting isn't consistent with price stability)

output supply shocks - NO (interest rate targeting isn't consistent with price stability)
What is the curent Federal Reserve Policy?
Set a target interest rate & revise the target every 6 weeks.
What happens in an economic boom?
workers are being fully utilized
aggregate capital stock is almost fully utilized
most machinery is running full time & plant is running 24 hrs/day
What happens in an economic recession?
workers are not fully utilized
aggregate captial stock is underutilized
most machinery is sitting idle & plants aren't running 24 hrs/day
Who is more connected to the financial markets in a segmented markets model?
firms are more connected.

business & consumers are not as well connected b.c they hold most of their wealth in savings accounts, transactions accounts, & housing
In the real business model how are TFP shocks?
TFP shocks are persistent in that an increase in current TFP causes an increase in future TFP
Classical Dichotomy
Real variable activity is seperate from nominal variable activity. For given output, more money is used to buy it b/c pricess have increased. The purchase power of money is unafffected - we have more money but everything is more expensive
According to real business cycle theorists, an increase in total factor productivity could lead to an expansion
because firms hire currently more labor and try to increase their future capital.
A price may be sticky because
of menu costs
Menu costs are
the cost of changing prices
What do we need to assume about firms in the sticky price model?
They accommodate any demand at the given price
The output gap is
the difference between market-clearing output and actual output
The central bank in the New Keynesian model pursues a policy of
targeting the market interest rate
In the New Keynesian model,
monetary policy has a real impact
In the New Keynesian model, the central bank achieves its interest rate target.
by the supplying the quantity of money demanded at the target interest rate
Fluctuations in the target interest rate in the New Keynesian model lead to all of the following except
countercyclical prices
Why are aggregate demand shocks not a good explanation of business cycles in the New Keynesian model?
Prices in the model are procyclical
Active stabilization policy can be rationalized in the New Keynesian model because
it allows a faster return to economic efficiency
Under monetary stabilization policy in the New Keynesian model, following a drop in output, the central bank should
decrease the interest rate
Under fiscal stabilization policy in the New Keynesian model, after a negative shock to output,
the government increases expenditures and the central bank increases the money supply
To support the argument for an active role for government in stabilizing the economy, it must be true that
not all wages and prices are flexible and that government must be able to react quickly enough
Consider two alternative worlds: (i) the world works according the real business cycle model, and the central bank acts to stabilize the price level; (ii) the world works according to the New Keynesian sticky price model, and the central bank acts to make the output gap zero. Which is correct?
We would prefer to live in world (ii) because policy can smooth fluctuations.
If prices in the New Keynesian model were perfectly flexible, then
the equilibrium real interest rate would be the natural rate of interest.
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