Chapter 8

Question 1

stabilization function

Answer 1

attempts by government to minimize fluctuations in
overall macroeconomic activity

Question 2

fiscal policy

Answer 2

Government policies related to spending and revenue generation

Question 3

monetary policy

Answer 3

Government policies which determine a nation’s Money Supply

Question 4

“The General Theory of Employment, Interest and Money” (1936) by John Maynard Keynes

Answer 4

a book, written against the backdrop of the Great Depression, which was
in many ways an assault on “traditional macroeconomic thought” (previous
argument was for direct control of the macroeconomy)
▪ central argument of “The General Theory…”: markets are volatile and might
not result in “full employment”

Question 5

expansionary fiscal policy

Answer 5

increases in government spending or decreases in taxes
with the aim of stimulating overall economic activity

Question 6

contractionary fiscal policy

Answer 6

decreases in government spending or increases
in taxes with the aim of dampening overall economic activity

Question 7

crowding out

Answer 7

decreases in private spending that occur following increases
in government spending
▪ as G is increased, does C remain constant or decrease? => a decrease in C
reveals “crowding out”
▪ If a significant amount of crowding out occurs, then the effectiveness of
stimulative Fiscal Policy will be reduced, since the government spending does not
create any new economic activity, but rather replaces private economic activity
with government economic activity (in a likely inefficient way)
▪ However, if instead productive resources are not fully employed, then government
spending will use otherwise idle resources and thus will generate new economic
activity => could lead to a significant short term increase in overall economic
activity as desired

Question 8

money supply

Answer 8

the amount of money in circulation in an economy (denoted M )

Question 9

velocity of money

Answer 9

the number of times that a typical dollar is used in market
transactions in a single year (denoted V )

Question 10

overall price level

Answer 10

the “average” of all the prices of goods/services traded (denoted
P )

Question 11

aggregate level of output

Answer 11

a measure of the real quantity of goods/services produced
(denoted Q )

Question 12

equation of exchange

Answer 12

an identity which relates the money supply, velocity of
money, overall price level, and aggregate level of output to each other: MV = PQ

Question 13

“A Monetary History of The United States, 1867-1960)” (1963) by Friedman and Anna Schwartz

Answer 13

provided strong evidence to support a claim that the money supply
has a direct impact on short run levels of income, employment, and inflation
▪ In the decades following WW-II “Monetarism” emerged as an alternative to
“Keynesianism” => Monetarism argued that economic fluctuations depended
more on Monetary Policy than on Fiscal Policy
▪ Milton Friedman (1912-2006; Nobel Prize in 1976

Question 14

loanable funds market

Answer 14

the collection of all markets in which lenders and borrowers
interact (e.g., mortgage markets, auto loan markets, consumer credit markets, business
loan markets)
▪ when loanable funds are more readily available, interest rates decrease =>
businesses are more inclined to build factories, expand production, and hire
workers, while households are more inclined to make major purchases
▪ starting at a point where Q is below its maximum, increasing the money supply
can lead to a real increase in economic activity (i.e., in Q )

Question 15

expansionary monetary policy

Answer 15

an increase in the money supply which provides
a short term stimulus to the macro-economy, resulting in higher levels of output,
employment, and incomes

Question 16

contractionary monetary policy

Answer 16

a decrease in the money supply which dampens
overall economic activity, resulting in lower levels of output, employment, and
incomes in the short term (but greater stability in the long term)

Question 17

central bank

Answer 17

entity which has the ability to alter the money supply of an economy
▪ Primary task is to control the nation’s money supply
Federal Reserve is an independent central bank, in that its actions are not
directly dictated by the legislative or executive branch
▪ experience suggests that independent central banks are better at promoting stable
economic growth and maintaining the value of a country’s currency => an
independent central bank is less vulnerable to short term political pressures

Question 18

fractional reserve banking system

Answer 18

a system in which at any point in time a
commercial bank is only required to retain a portion of the money it has accepted as
deposits

Question 19

open market operations

Answer 19

buying and selling of U.S. Treasury debt securities
to and from the public
o buying bonds puts more money in circulation (increases money
supply); selling bonds takes money out of circulation (decreases money
supply)

Question 20

setting of reserve requirements

Answer 20

minimum restrictions on the amount of money
that a bank must keep on hand at any point in time, in the form of either cash in its
vault or deposits with the central bank
o lowering the reserve requirement increases the money supply; raising
the reserve requirement decreases the money supply

Question 21

setting of discount rate

Answer 21

setting the interest rate that the Fed charges banks
on short-term loans
o lowering the discount rate increases the money supply; raising
the discount rate decreases the money supply