1. Use only 1 or 2 sentences only to answer in terms of economic concepts. [10 points] a. What are automatic stabilizers?
Automatic stabilizers are part of the fiscal policy and are built into the federal/state/local tax and transfer systems. They are put in place to stimulate aggregate demand in a recession without the need for action by policymakers. Corporate and personal income taxes are the best-known automatic stabilizers. For example: when the economy is in its growth stage, our progressive tax system automatically reduces money supply, as income rises. When the economy turns into a recession, payments of unemployment benefits and food stamps inject more money into the system to help stimulate demand. b. How would currency depreciation affect aggregate demand? When an increase in the supply of currency occurs, the currency loses value, or its price decreases. A decrease in currency price would cause the aggregate demand curve to shift to the downward right. A lower currency price means less demand for the currency. The book uses a great example with the country Zimbabwe. In 2002, the Zimbabwe government increased its supply of money drastically. This caused currency depreciation and very high inflation for the country’s people. The Zimbabwe Dollar was worth around 2 cents US Dollar. By 2006 the depreciation had grown and the new currency price was 0.00001 or one-thousandth of a US Dollar. This has made the Zimbabwe dollar very repealing compared to other world currencies. Therefore, the aggregate demand for Zimbabwe Dollar has decreased immensely. c. Why would someone want currency from another nation?
The reason someone would favor say the British pound over the US Dollar is because the British pound holds more value. $1.61 equals about 1 British pound making the pound more desirable and attractive to investors. After the financial crisis of 2008, the US Dollar suffered and the government was forced to print a lot of money and this created depreciation in the dollar and made investors extremely worried. Many of them converted all their assets into Euros or Pounds in order to better protect their wealth. d. What is the yield curve? Which part can the Fed control more easily? The yield curve shows the relation between the level of interest and the time it matures. The most common yield curve illustrated is the US debt curve on its Treasury Notes. As the note or bond maturity lengthens, the yields will rise. The Fed can control the interest rates more easily than it can control inflation or employment. Through open market operations, the discount rate, and reserve requirements, the Fed can influence the supply and demand for reserve balances. When the Fed lowers the federal funds rate, it allows central banks to lower their
interest rates to their investors. This helps push the economy forward and motivates investors to spend their money. e. Canada’s economy is heavily influence by the price of oil. If the price of oil rises, would you prefer to buy or sell the Canadian dollar? If the price of oil rises I would prefer to buy the Canadian dollar because the first principle of demand for a currency states that as a country’s exports increase so does the value of its currency. Higher oil prices means higher returns. High oil prices would make Canada more desirable to foreign investment, thus raising its value of its currency and strengthening my personal portfolio. Therefore, transferring all of my assets into Canadian dollars would be the smart move.
2. When the Fed wants to increase the federal funds rate, what action to do they undertake? Clearly explain how the Fed’s action leads to an increase in the federal funds rate. What might cause the Fed’s policies to be ineffective? [5 points] The Fed will sell bonds until the federal funds rate increases by a desired amount. When the Fed does this they are simply decreasing the money supply by removing cash from the...
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