Interest RatesRate at which we borrow and lend using other’s funds and paying for itWhere do interest rates come from?Supply & demand by lenders & borrowersMonetary policyis changes in interest rates & “money supply” by a country’s “central bank” (part of thegovernment)- U.S. cent. bank: Federal Reserve (“Fed”) -> Bank for banksFed’s “dual mandate” from Congress:“promote effectively the goals ofmaximum employment, stable prices*and moderate long-term interestrates”*Stable prices – Fed takes as 2% inflation.- Key Fed tool –federal fundsinterest rate• what banks charge each other for overnight loans – now at 1.25%Fiscal Policy- changes in federal expenditures & taxes• these 2 are changedindependently*- controlled by the President & CongressGovernment budgetdeficit= federal expenditures – federal taxesFunds for thedeficitcome from the U.S. Treasury borrowing frominvestorsby selling them bondsFederaldebt: total amount of bonds sold or the accumulateddeficitsfederal debt:$14.6 trillion (77% of GDP)Interest payments on the federal debt: $269 billion (1.4% of GDP)borrowing (deficit) pays for any expenditures not covered by taxesfederaldebt= accumulateddeficitsGDP DeflatorUses nominal & real GDP to measure the “price level” (average price of all goods and services in an economy)def:GDP deflator = (nominal GDP/real GDP) • 100The GDP deflator is a “price index.”inflation = %Δ price index%Δ GDP deflator = inflation%Δ real GDP = economic growth%Δ "="("final - initial" /"initial" ) • 100high prices ≠ high inflation.Deflationis a fall in prices whiledisinflationis less inflationThe CPI can be used to remove inflation from nominal prices & wages
