A. Barter System – The barter system does not make the use of money but is a system that is used to exchange goods or services for the possession of other goods or services. Example – In a country like Venezuela where the country is experiencing hyperinflation and prefers the barter system better, I would pay the shopkeeper a bag full of corn for 5 carrots in this case.
Commodity Money – It is money that consists of objects (assets) that have value in themselves and can be used as a medium of exchange. For example – Items such as gold, silver, precious stones, etc. have value in them that can be used as money in order to buy anything in the market.
Fiat Money – It is paper money whose value is being legalized by the government and has functions like – medium of exchange, unit of account and store of value. For example – A $10 bill used to buy pencils from Staples.
Stocks – Stocks are a part of an investment that represent a share on a company’s assets and earnings. Example -If have invested in a chocolate company along with other investors and I have a share of 7% of the total earnings, this 7% will be a part of my stocks that will be given to me.
Bonds – It is form of borrowing where an investor lends money for a certain amount of time in order to gain from a given interest rate. Example – The Federal Reserve buys bonds in the open market to increase money supply in the economy.
B. Transaction money for demand – It is the amount of money required for an individual’s’ current transaction which can fulfill their needs. Example – If I start earning $60K instead of $50K a year, there will be more money in the bank account and hence my transaction money for demand will increase.
Asset Demand for money – Asset Demand for money is when assets in the form of money are being bought and saved for later use. Example – I buy jewellery in 2000 at a very low price and I continue to use it as the price of gold in 2019 has increased.
C. The reserve requirement – It is the required amount of cash that every bank needs and is acquired from its customers’ deposits. Example – Bank of America in Farmington has about $20B in its reserves that consists of its customers’ deposits.
Money Multiplier – It is the measure of customer deposits to the reserves in a bank. It also measures the effect of required reserves on the money supply. Example – If the reserves has about $30K and the money supply is $90K, then the money multiplier is 90K/30K = 30.
D. Fiscal policy – These are policies enforced by the Congress to control things like its spending and tax rates that will ultimately have an effect on the nation’s economy. Example – The Congress uses fiscal policies like the contractionary policy in an inflationary situation to decrease its spending and increase taxes so that aggregate demand shifts back at LRAS.
Monetary policy – These are policies that are controlled by central banks in order to fluctuate interest rates and the supply of money. Example – The expansionary monetary policy decreases the discount rate so that it increases excess reserves and increases the money supply.
A. During a recessionary situation, a fiscal policy that would help to close the gap would be the expansionary fiscal policy. This policy comprises of decreasing taxes and increasing government spending that both would increase aggregate demand and will combat recession. A monetary policy that would close this gap would also be the expansionary monetary policy that would keep the interest rates low that would result in increased amount of borrowing from the banks and an increase in aggregate demand. Central banks uses three tools to combat recession like the Fed buys bonds, decreasing the discount rate and reducing reserve ratio to attract more loans. These actions would result in an increase in aggregate demand and hence the recessionary gap would be closed and the economy will return to full employment. When open market operations are in use to overcome recession, the Fed buys bonds that push prices higher and this results in a decrease in interest rates and would increase aggregate demand to close recessionary gap.
B. The Fed should sell bonds to decrease money supply, increase interest rates to slow the borrowing rate and an increase reserve ratio . An increase in interest rates makes borrowing more expensive and hence it discourages businesses to make investments. Furthermore, when consumers are spending more money on interest rates as they have increased, they have less money to spend and hence this forces them to save rather than spending it.
This way, it affects consumption. Monetary policies are more effective than fiscal policies because of problems like the crowding out effect. If the Congress decides to use to contractionary policy to increase and decrease government expenditures, it would shift aggregate demand back to LRAS in the short run but in the long run, high taxes would discourage investment and hence it would lead to a recession. On the other hand, if monetary policy were to be used in this scenario to increase interest rates, it would make it difficult for people to borrow money and hence it will lower money supply. It would also cause the US currency to appreciate as it attracts foreign investment. Because of this, the economy would be better off with the use of monetary policy to combat inflation.
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