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U.S. central bank = Federal Reserve (“Fed”) - established by Congress andmost key positions appointed by the president and confirmed by SenateYet the Fed is largely independent of the federal government by lawFed’s “dual mandate” from Congress: “promote effectively the goals of maximum employment, stable prices*, and mbn hoderate long-term interest rates” *stable prices - Fed takes as 2% inflationFed Chair: Janet Yellen, also heads the “Federal Open Market Committee” (FOMC)Key Fed tool - federal funds interest rateWhat banks charge each other for overnight loans: $100M
FOMC sets this rate - now at 1.25%It in turn influences other interest ratesoHow the Fed affects U.S.The FOMC increases federal funds interest rate → higher costs for banks → loan rates for consumers and firms increase → more expensive for firms and consumers to buy goods with credit → slower growth (%Δ real GDP) → fewer jobs created, harder time finding a job, and fewer new firms →less inflationas smaller increases in demand for goods and servicesWhy would the Fed do this? Achieve 2% inflation (part of their dual mandate)Fiscal policy:oChanges in federal expenditures and taxesThese 2 are changed independently oControlled by the president and congress oGovernment budget deficit = federal expenditures - federal taxesEx: 2017$693 bil. = $4,008 bil - $3,315 bil3.7% = 21.0% - 17.3% (of GDP)Funds for the deficit come from the U.S. Treasury borrowing from investors by selling them bondsFederal debt: total amount of bonds sold or the accumulated deficitsFederal debt: $14.6 trillion (77% of GDP) Interest payments on the federal debt: $269 billion (14% of GDP)Deficit = federal expenditures - federal taxesoDecreasing federal expenditures and/or increasing federal taxes will decrease deficitFederal government (president and congress) set federal expenditures and taxes (fiscal policy) - borrowing (deficit) pays for any expenditures not covered by taxesoFederal debt = accumulated deficitsfederal expenditures: $4,008 billion (21.0% of GDP)federal taxes: $3,315 billion (17.3% of GDP)deficit: $693 billion (3.7% of GDP)Federal debt: $14.6 trillion (77% of GDP)3.Be able to calculate the GDP deflator and CPI and explain what they measure. (Ch. 8.3 & 9.4 and notes)
GDP deflator: a measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100oGDP deflator = Nominal GDP x 100Real GDPConsumer price index (CPI): a measure of the average change over time in theprices a typical urban family of four paysfor the goods and services they purchaseoAlso called “cost-of-living” indexoCPI is intended to measure changes in the price level over timeCPI = Expenditures in the current yearX 100Expenditures in the base year4.Be able to explain the limitations of GDP and the CPI. (Ch. 8.2 & 9.4)Limitations of GDPHousehold production and personal useoEx: a person cleaning their own house - value of this service is not counted in GDP - hiring a maid to clean would beUnderground economyoEx: drugs, prostitutionWell-beingo