econ201 Flashcards
(45 cards)
What happens to interest rates and output when the money supply increases in the short run?
Interest rates fall, output rises due to increased aggregate demand.
In the long run, how does an increase in the money supply affect real GDP?
It does not change real GDP; it only increases the price level.
If net exports are positive, what can you infer about net capital outflow?
Net capital outflow is positive—foreign assets bought by Americans exceed U.S. assets bought by foreigners.
What does a rightward shift in the money supply curve do to aggregate demand?
It increases aggregate demand by lowering interest rates and encouraging investment.
What causes the money demand curve to shift right?
An increase in the price level (P) increases the demand for money.
According to the classical dichotomy, what variables are affected by changes in the money supply?
Only nominal variables (e.g., price level), not real variables like output.
What is the formula for the money multiplier?
Money multiplier = 1 / reserve ratio.
What happens to U.S. interest rates and the exchange rate when there is capital inflow?
Interest rates fall, the U.S. dollar appreciates.
What happens to the real exchange rate when the nominal exchange rate falls and prices are unchanged?
The real exchange rate also falls.
What causes stagflation?
A leftward shift in short-run aggregate supply.
If a country increases its budget deficit, what happens to net capital outflow and its currency in foreign exchange?
Net capital outflow falls; the supply of the currency in foreign exchange decreases.
What is the interest-rate effect in the AD curve?
Higher price level → higher money demand → higher interest rates → lower investment → lower AD.
How does a recession in other countries affect U.S. aggregate demand?
It reduces U.S. net exports and shifts aggregate demand left.
Why do banks avoid holding more reserves than required?
Excess reserves don’t earn interest, so banks prefer to lend them out for profit.
How does an increase in the money supply affect the value of money?
It decreases the value of money (1/P), causing the price level to rise.
What is the sacrifice ratio?
The number of percentage points of annual output lost (as a percent of GDP) to reduce inflation by 1 percentage point.
If the sacrifice ratio is 4 and the Fed wants to reduce inflation by 3 percentage points, how much output must be sacrificed?
4 × 3 = 12% of annual output.
Why does reducing inflation often cause a recession?
Because contractionary policies reduce demand, lowering inflation but also reducing output and raising unemployment.
What is disinflation?
A reduction in the rate of inflation (not deflation, which is falling prices).
How can the Fed reduce inflation?
By using contractionary monetary policy—reducing the money supply or raising interest rates.
What is the short-run effect of contractionary monetary policy?
Output falls, unemployment rises, inflation declines.
What is the long-run effect of contractionary monetary policy?
Price level decreases, but real GDP returns to its natural rate; unemployment returns to the natural rate.
Why might the Fed be hesitant to reduce inflation quickly?
A fast reduction causes larger output losses—higher sacrifice ratio.
How does the Phillips Curve relate to disinflation?
Disinflation involves moving down the short-run Phillips Curve—lower inflation, but higher unemployment in the short run.
