CLEP Macro Economics

Contractionary policies reign in excess growth o to

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Contractionary policies reign in excess growth o To prevent prices and inflation from rising to the point that supply of output of goods and services grow to a point that spirals out of control and supply will exceed demand Aimed at reducing spending and output o Examples : Higher taxes and reduced government spending Contractionary policies result in a surplus The Fed will sell U.S. Treasury securities on the open market, banks use their reserve to purchase these securities, resulting in banks having less money in their reserve, thus, banks will not lend as much to individuals and business, interest rates increase, and overall money supply decreases, economy slows down, production decreases, as a result fewer goods are produced, unemployment increases, prices drop, inflation drops Anchored Inflation – occur when people’s expectations of future inflation do not change even though inflation rates change
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When inflationary expectations are anchored, output levels are likely to stabilize quickly and recessions are likely to be shorter Core rate of Inflation – the rate of price increase on all things except food or energy Core rate of inflation is a good tool to measure the current inflation trends because it removes the two most volatile elements, food and energy, from the numbers Credibility of Monetary Policy – directly effects the nation’s anchored inflationary expectations If people believe the Federal Reserve will keep interest rates low, then their anchored expectations will remain low Fisher effect – is the tendency for nominal interest rates to be high when inflation rates are low Irving Fisher was an early 20 th century economist that pointed out the relationship between the nominal interest rates and inflation rate Phillips Curve – demonstrates that there is an inverse relationship between inflation and unemployment As inflation increases, unemployment decreases (and vice versa) As inflation decreases, unemployment increases (and vice versa) Does not hold true during periods of stagflation in which high inflation and high unemployment occur simultaneously Demand-Pull Inflation - is a result of an increase in price levels when total spending exceeds total production Excess demand drives prices sky high o Example: a new video game during Christmas; demand is high, game will sell for higher retail prices GDP Deflator Equation – the level of inflation of all goods and services produced in a certain economy (nominal GDP/Real GDP) x 100 Good short-term measure of price changes and worth Personal Consumption Expenditure Index (PCE) – is a way to measure inflation based on year-to-year consumer spending PCE differs from CPI (consumer price index) in that it takes into account medial spending, more accurate measure of inflation Government Bonds – sold to curb inflation, the most common tool the Fed uses that directly affects the money supply by buying and selling bonds By selling government bonds, the Fed removes money from the economy, which drives up interest rates
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Contractionary policies reign in excess growth o To prevent...

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