article discussion Flashcards
tight monetary policy
refers to a set of actions taken by a central bank
to REDUCE the MONEY SUPPLY and CURB INFLATION
goals of tight monetary policy
(reduce money supply and curb inflation)
- slow down economic activity
- control inflation
- prevent economy from overheating
key actions associated with tight monetary policy
- raising interest rates
- selling government securities
- increasing reserve requirements
raising interest rates (in context of tight monetary policy)
when central banks increase interest rates, borrowing becomes more expensive
leads to less borrowing and spending by businesses and consumers
selling government securities (in context of tight monetary policy)
by selling bonds, the central bank reduces the money supply in the economy
as people exchange money for bonds
increasing reserve requirements (in context of tight monetary policy)
central banks may require commercial banks to hold more reserves
which means they have less money to lend out, further restricting the money supply
explain the transmission mechanism implied by the author when he says that “higher interest rates in America can cause a rise in unemployment”
- higher interest rates increase the cost of investment and consumption
- investment and consumption decrease
- AD shifts to the left, reducing output
- a reduction in output increases unemployment
elaborate on how increase in interest rates can potentially trigger a housing market crash, and what repercussions this would have for the US economy
- increased interest rates increase the cost of borrowing for homebuyers. the affordability of mortgages decreases. this leads to a decrease in the demand for housing
- lower demand for housing can cause prices to drop
- this is a negative wealth effect that could lead to a reduction in consumer spending
- this can be represented by a leftward shift of the AD curve
- this would move the economy into an equilibrium with lower GDP and higher unemployment
negative wealth effect
refers to a situation where a DECREASE in the VALUE OF ASSETS (stocks, real estate, other investments)
leads to REDUCTION IN CONSUMER SPENDING
when people feel less wealthy (because the value of their assets have declined), they cut back on spending
this hurt businesses, leading to slower economy and unemployment
provide an explanation for why the author claims that “tight money has brought about a strong dollar”
- tight money policy aims to curb inflation by reducing the money supply
- this reduction means that the interest rate in Canada will increase
- the high interest rate will attract investment from abroad
- this investment will lead to an appreciation of the Canadian dollar, as in order to buy Canadian bonds people must convert to Canadian currency
consider emerging market economies - explain why a strong dollar is causing inflation to be exported to emerging markets
strong dollar causes inflation to be exported to emerging markets primarily through its impact on INTERNATIONAL TRADE
1a) when the US dollar strengthens, it can lead to an increase in the prices of IMPORTED PRODUCTS in the LOCAL CURRENCIES of EMERGING MARKETS
1b) this is because with a strong US dollar, a higher amount of local currency has to be paid for US imported goods
1c) as the cost of imports rises, it can DRIVE UP INFLATION in emerging markets (imported raw materials, inputs - so inflation is passed on to consumers)
2a) furthermore, a strong dollar can lead to CAPITAL OUTFLOWS from emerging markets as investors seek HIGHER RETURNS in the US
2b) this depreciates their currency even more, making imports increasingly expensive
“Europe is grappling with a severe energy crisis that’s shutting down factories and hurting consumers” - represent in a diagram with AD and AS the effects of the energy crisis in Europe
- the energy crisis shutting down factories implies a reduction in aggregate supply
- this means that the AS curve is shifting leftward as a result of reduced availability of energy resources
- this implies decreased production ability and increased production costs
- equilibrium output will decrease and price level will increase
- this means there has been a recessionary effect on the European economy, with high inflation
discuss why the author says that “the severity of the downturn depends significantly on the weather”
weather conditions can affect the impact of the energy crisis
severe weather conditions (extremely cold winters or heatwave) exacerbate the energy crisis by increasing energy demand for heating or cooling
such conditions further strain energy resources and infrastructure, leading to more severe disruptions in energy supply and greater economic consequences
consider the Chinese economy - use an AD and AS diagram to rep the effect of “the housing-market crash and zero-covid policy” of the Chinese economy
- both factors contribute to a leftward shift in AD curve
- housing market crash reduces household wealth and consumer confidence, leading to decreased consumer spending
- zero-covid policy introduces stringent lockdowns and restrictions, making consumption difficult as people face hurdles in spending due to limited access to goods and services
- these measures directly impact investment and consumption, further contributing to AD’s leftward shift
- zero-covid policy complicates work and lower labour force participation - disrupts normal functioning of businesses and makes it hard for employees to physically attend work
- reduces labour productivity and capacity - this leads to a leftward shift in the AS curve
COMBINED EFFECT OF HOUSING MARKET CRASH AND ZERO COVID POLICY RESULTS IN LOWER AD AND LOWER AS
this leads to reduced equilibrium output, indicating an ECONOMIC SLOWDOWN in China
explain tensions between FISCAL and MONETARY policies, with a focus on Europe. discuss origins of these tensions, considering diff priorities of central bankers and politicians. use AD and AS curve to support your explanations
in Europe - tension between fiscal and monetary policy arises from a NEGATIVE AS SHOCK (specifically, high energy prices)
shock reduces output and raises prices
central bank targets inflation by increasing interest rates to shift AD leftward (lowers prices - reduces inflation)
simultaneously, governments are concerned about economic outlook - and they may implement expansionary fiscal policies to boost AD (shift AD rightward)
their aim is to increase GDP but this potentially exacerbates inflation
CREATES TENSION AS FISCAL AND MONETARY POLICIES PULL IN OPPOSITE DIRECTIONS - reflects challenges of addressing negative AS shocks while balancing inflation and economic output
fiscal austerity
set of policies aiming at REDUCING GOV SPENDING and/or INCREASING TAXES
in order to achieve fiscal discipline and REDUCE BUDGET DEFICITS or the size of national debt
how does fiscal austerity contribute to Europe’s growth problem?
- by directly reducing AD
(through reducing gov spending and reducing investment)
- and by indirectly weakening long-run growth potential
explain this statement - “fiscal tightening (cutting deficits) in a weak economy is pro-cyclical”
fiscal tightening (reducing gov spending and investment/leftward AD shift) in a weak economy is pro-cyclical
it reduces government spending and demand when stimulus is needed
this obstructs growth, worsening the slowdown and increasing the risk of stagnation
EU’s structural weaknesses limit its ability to grow
- DEMOGRAPHICS: ageing populations reduce productivity and increase spending on pensions and healthcare, pushing up government costs without boosting output
- FISCAL RULES: (like the EU’s new deficit reduction targets and Germany’s constitutional “debt brake”) force countries like France and Italy to cut deficits by 0.5% of GDP annually, leaving less room for public investment and limiting support for growth-enhancing principles
in class, we discussed that increase in G could increase interest rates and crowd out private investment. do you think the decision of the ECB last week to cut interest rates could help Europe?
- increase in G means governments need to BORROW MONEY to finance their spending - they do this by ISSUING BONDS in the financial markets
- this increases the DEMAND FOR LOANABLE FUNDS (the money available to borrow)
- as gov borrows more money, it competes with PRIVATE BORROWERS in the market for available funds - when demands for borrowing increases but the supply of funds doesn’t change, the COST OF BORROWING INCREASES
- this is reflected in HIGHER INTEREST RATES
- higher interest rates make borrowing MORE EXPENSIVE for private businesses - discourages them from taking out loans to invest in new projects, expand operations, hire more workers etc
^ this is “CROWDING OUT”
YES IT COULD HELP - BECAUSE AD WOULD SHIFT LEFT AS THE COST OF BORROWING DECREASED
if fiscal consolidation reduces potential output growth, how might that in turn affect public finances? could cutting deficits today make it harder to achieve fiscal sustainability in the long run? why/why not?
- fiscal consolidation (austerity) can reduce PUBLIC INVESTMENT in infrastructure, education and research & development
^ this lowers potential output growth over time by weakening productivity and human capital formation
- lower growth = lower future tax revenue
- debt-to-GDP ratio worsens if growth slows
why Biden will need to spend big - discuss how the model covered in class could be used to analyze the COVID 19 crisis
- AD shifted leftwards - people experienced barriers to spending on goods and services
^ led to lower output and lower employment
- AS shifted leftwards - inability to conduct work as normal lowered productivity and decreased output
^ led to lower output and higher prices
- the combined effect of a recession (lower output) and potentially stagflation (higher prices and lower growth)
^ depending on which shock dominates
in the COVID US situation, what’s the effect of an increase in gov investment?
- increases AD through higher gov investment/spending
- AD shifts rightward - increases output and employment
- long term growth via investments in infrastructure, education, technology
^ can enhance productivity and lead to sustainable economic growth
following Paul Krugman’s discussion, why’s the current situation special and why should the gov be less concerned about the cost of debt?
- historically low interest rates
^ gov borrowing is very cheap right now - this means the cost of debt is low, so it’s not a burden to borrow more
- high demand for safe assets
^ investors want to hold safe assets, like US gov bonds. this keeps bond yields (interest rates) low and makes it easy for gov to finance deficits. people are parking their money in a safe place, allowing the gov to borrow without too much inflation risk or competition
- risk of doing too little = bigger than risk of debt
^ if gov fails to stimulate the economy, downturn could last longer
