Section Six Review

INFLATION, UNEMPLOYMENT, AND STABILIZATION POLICIES

Cheat Sheet Notes

Module 30
Cyclically adjusted budget
o Remember: expansionary fiscal policy closes up recessionary gaps and
reduces the budget balance, contractionary fiscal policy closes down
inflationary gaps and increases the budget balance
o Savings by government OR the budget balance = taxes government
spending transfers
o Changes in the budget balanced often caused by business cycle
Recessions = deficits, good econ = surpluses
o Cyclically adjusted budget balance shows if real GDP = potential output
on the budget balance; indicates whether a govs econ policy is
sustainable
o Should we keep the budget balanced? Not quite; should only budget
balance on average (let deficits be balanced out by times of surpluses)
Public debt
o If gov keeps borrowing, it gets deeper into debt
National debt = accumulated deficits accumulated surpluses
Public debt: debt held by institutions, individuals
o Problems: crowding out, financial pressure on future budgets, hard to
solve debt (printing money=inflation, more borrowing=bankruptcy,
raising taxes=political suicide)
Implicit liabilities
o Debt-GDP ratio: debt/GDP, debt/income. Used to show potential taxes
gov can collect
o Implicit liabilities: spending promises made by gov, basically debt
Social Security and Medicare rising
Module 31
Monetary policy
o Increase MS, decrease IR; decrease MS, increase IR
o Feds often set a target federal funds rate and make open market operations
to follow through
If initial FFR is below their target, they decrease money supply
If initial FFR is above their target, they increase money supply
o Expansionary monetary policy (increases MS), so decreases IR
o Contractionary monetary policy (decreases MS), so increases IR
o Fed also monitors inflation through Taylor rule
Fed funds rate = 1+(1.5 x inflation rate) + (0.5 x output gap)
o Other places use deflation targeting

Module 32
Short-run, long-run money supply
o Money neutrality: in the long run, the Fed changing the money supply
wont affect GDP/the economy
o All it really does is change price levels over long-run
Module 33
Inflation
o In terms of hyperinflation, the classical model of the price level can be
helpful (not helpful anywhere else); this model immediately leaps to longrun equilibrium
o Gov often just prints more money to help pay for stuff; with Fed
monetizing the debt
Seignorage is the right of the government to print money
Seignorage= monthly change in MS
Real seignorage = change in MS/price level OR (change in
M/M) X (M/P)
When gov prints money to pay for its debts, it imposes an inflation
tax on its citizens since their money is now worth less in return
o Cost push inflation: inflation caused by an inputs price increase
o Demand pull inflation: inflation caused by aggregate demand increasing
Figuring in unemployment
o If the output gap is positive, potential output rises, unemployment
decreases
o If the output gap is negative, potential output lowers, unemployment
increases
o If the actual output is at potential output, unemployment = natural rate of
unemployment (frictional + structural unemployment)
Module 34
Phillips curve
o Unemployment and inflation negatively correlated
o Short-run Phillips curve made to show this
Movements along the SRPC caused by: shifts in AD (shifting AD
up, movement up the SRPC. Shifting AD down, movement down
SRPC)
Shifts of the SRPC caused by: supply shocks (SRAS shifts up,
SRPC shifts down; SRAS shifts down, SRPC shifts up) and
changes in expected inflation (expected inflation increases, SRPC
increases; expected inflation decreases, SRPC decreases)
Just draw AD-AS graph and SRPC/LRPC graph side-by-side
o The LRPC basically shows that no matter how much you try to lower
unemployment with higher inflation, youre really just accelerating the

inflation too much and must keep a certain amount of unemployed

naturally (NAIRU)
Disinflation saps output and leads to high unemployment
Debt deflation, zero bound, liquidity traps

Module 35
History
o Classical economists
Prices flexible, SRAS vertical
Changes in MS change the price level proportionally, but no change to
aggro output (because they dont care about short-run)
Increases in MS are the only causes of inflation
No consensus on business cycle, just stuck to no gov intervention
o Keynesians
Short run shifts in AD do affect price level and agro output
The short run was important to Keynes
There are certain shifters of the AD curve (like business confidence)
Macroeconomic policy activism: using fiscal and monetary policy to
help business cycle
o Monetarists
Monetary policy can revive business cycle; GDP will grow steadily as
the MS grows steadily (later disproven)
Didnt like discretionary monetary policy (changing interest rates with
policy)
Wanted a monetary policy rule to give central bank guidance
Quantity Theory of Money: Price levels and money supply
positively correlated
Velocity of money measures this (velocity= money supply x
velocity=agro price level x real gdp)
o Natural Rate Hypothesis
Used to show natural rate of unemployment, limited gov intervention
in employment, policy only to stabilize econ
Political business cycles made people want the Fed isolated from
politics
o New classical economists: back to prices change, not GDP
Rational expectations: People have knowledge of current
fiscal/monetary policy and use that knowledge to realize expected
inflation should go up
Real business cycle theory: productivity main changer in business
cycle
o New Keynesians: market imperfections lead to price stickiness, so AD does
change output
Module 36

Modern consensus
o Monetary and fiscal policy good in SR treating recessions, neither do
anything to unemployment in LR
o Discretionary fiscal policy ineffective except with weird circumstances
like liquidity traps
o Still conflicts over monetary policy
Should we use inflation targeting or not?
Should we manage asset prices?
What do we do to stop liquidity traps?

Quizlet Links
All vocab from this section (31 words)
http://quizlet.com/78316615/ap-econ-section-6-vocab-flash-cards/
All equations from this section (8)
http://quizlet.com/78328283/ap-econ-section-6-equations-flash-cards/

Practice Problems/More Info

http://bernardsboe.oncoursesystems.com/school/webpage/documents/PGA9cfXP
D99hPPG45d/4872908-344845/downloadFile.aspx
https://www.scribd.com/doc/169602743/Krugman-and-wells-Ch-17