S central bank federal reserve fed established by

U.S. central bank = Federal Reserve (“Fed”) - established by Congress and
most key positions appointed by the president and confirmed by Senate

Yet the Fed is largely independent of the federal government by
law

Fed’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% inflation

Fed Chair: Janet Yellen, also heads the “Federal Open Market
Committee” (FOMC)

Key Fed tool - federal funds interest rate

What banks charge each other for overnight loans: $100M


FOMC sets this rate - now at 1.25%

It in turn influences other interest rates
o
How 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 inflation as smaller
increases in demand for goods and services

Why would the Fed do this? Achieve 2% inflation (part of their
dual mandate)

Fiscal policy:
o
Changes in federal expenditures and taxes

These 2 are changed independently
o
Controlled by the president and congress
o
Government budget deficit = federal expenditures - federal taxes

Ex: 2017

$693 bil. = $4,008 bil - $3,315 bil

3.7% = 21.0% - 17.3% (of GDP)

Funds for the deficit come from the U.S. Treasury borrowing from
investors by selling them bonds

Federal debt: total amount of bonds sold or the accumulated deficits

Federal debt: $14.6 trillion (77% of GDP)

Interest payments on the federal debt: $269 billion (14% of GDP)

Deficit = federal expenditures - federal taxes
o
Decreasing federal expenditures and/or increasing federal taxes
will decrease deficit

Federal government (president and congress) set federal expenditures and
taxes (fiscal policy) - borrowing (deficit) pays for any expenditures not
covered by taxes
o
Federal debt = accumulated deficits
federal 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 100
o
GDP deflator = Nominal GDP x 100
Real GDP
 Consumer price index (CPI) : a measure of the average change over time in the
prices a typical urban family of four pays for the goods and services they
purchase
o Also called “cost-of-living” index
o CPI is intended to measure changes in the price level over time
CPI = Expenditures in the current year X 100
Expenditures in the base year
4. Be able to explain the limitations of GDP and the CPI. (Ch. 8.2 & 9.4)
Limitations of GDP

Household production and personal use
o
Ex: a person cleaning their own house - value of this service is not
counted in GDP - hiring a maid to clean would be

Underground economy
o
Ex: drugs, prostitution

Well-being
o