Final Exam Deadline For Submitting The Text

Final Examinationthe Deadline For Handing In The Text Of This Final Ex

Final Examinationthe Deadline For Handing In The Text Of This Final Ex

FINAL EXAMINATION THE DEADLINE FOR HANDING IN THE TEXT OF THIS FINAL EXAM TO DR. KANDEL IS DECEMBER 10, 2020. AN ABSENCE OF THE TEXT BY THE MORNING, DECEMBER 11, WILL BE AWARDED BY A ZERO SCORE. Question I. 80 pts. Question II. 120 pts Question III. 120 pts Total 320 points Question I. 80 pts. Explain how the Federal Reserve System influences the lending activities of its member banks. The way the federal reserve system influences the lending activities of its members is through I.1. 20 pts. Explain the mechanism of fractional reserves and deposit creation. - YOUR ANSWER I.2. 30 pts. Explain how the Federal Reserve System (FED) influences the lending activities of its member banks during recessions. YOUR ANSWER I.3. 30 pts. Explain how the FED influences the lending activities of its member banks during the states of the US economy, which FED diagnoses as ‘overheating.’ YOUR ANSWER Question II. 120 pts Explain the core intermediate transactional phases that influence the levels of macroeconomic demand and supply in the U.S. economy. II.1. 40 pts. Explain the circular flows of income and capital at the macroeconomic level. The overall diagram should illustrate your explanations. If needed, in addition to the overall diagram apply diagrams of specific intermediate transactional phases. YOUR ANSWER II.2. 80 pts. Uncertainty about future inflation may ruin a particular intermediate transactional phase. Describe this phase and explain conditions under which transactions inside this phase are facilitated or become prohibitively costly. II.2.1. 25 pts. Describe and explain the phase. YOUR ANSWER II.2.2. 25 pts. Describe and explain how banks set interest rates on typical loans. YOUR ANSWER II.2.3. 30 pts. Describe and explain conditions under which borrowing is facilitated or become prohibitively costly. YOUR ANSWER Question III. 120 pts Explain the foundations of the traditional stabilization policy and supply-side economics by using the Aggregate Demand--Aggregate Supply diagram. III.1. 30 pts. Explain the logic of assigning macroeconomic variables to the axes of the Aggregate Demand--Aggregate Supply diagram. 1 YOUR ANSWER III.2. 40 pts. Explain the foundations of the traditional stabilization policy and unemployment-inflation tradeoffs by using the Aggregate Demand--Aggregate Supply diagram. YOUR ANSWER III.3. 50 pts. Explain the foundations of the supply-side economics, the absence of unemployment-inflation tradeoffs, and expansion of Aggregate demand by using the Aggregate Demand--Aggregate Supply diagram.

Paper For Above instruction

Introduction

The complex interactions within macroeconomic frameworks, monetary policies, and fiscal strategies shape the economic landscape of the United States. Understanding the Federal Reserve's influence on banking lending activities, the phases of macroeconomic demand and supply, and the principles behind stabilization and supply-side economics is crucial for comprehending broader economic dynamics. This paper explores these interconnected topics, elucidating the mechanisms and theories that underpin current economic policies and systems.

Section I: Influence of the Federal Reserve on Bank Lending

The Federal Reserve System (Fed) operates as the central banking authority in the United States, exerting significant influence over the lending activities of its member banks through various mechanisms. A foundational tool is the fractional reserve banking system, which mandates that banks hold a fraction of their deposits as reserves. This system facilitates deposit creation and expands the money supply via banks' lending activities (Cecchetti & Schoenholtz, 2014).

Initially, banks receive deposits and are required to hold a certain reserve ratio, but they can lend out the remaining funds. The recipients of these loans often deposit the borrowed funds into their banks, creating new deposits and thus expanding the money supply further—this process is known as deposit or credit creation (Bernanke & Mishkin, 2008). The Fed influences these lending behaviors primarily through three channels: setting reserve requirements, influencing interest rates via open market operations, and using discount rates.

During recessions, the Fed typically adopts expansionary policies to stimulate lending. It lowers target interest rates through open market operations, wherein it purchases government securities, increasing banks' reserves and enabling them to lend more freely. It also reduces the discount rate, which is the rate at which banks borrow from the Fed, encouraging banks to seek cheaper funds (Mishkin, 2015). Conversely, during overheating periods, the Fed may tighten monetary policy by raising interest rates and reserve requirements to curb excessive lending and inflationary pressures (Goodfriend, 2007).

Section II: Macroeconomic Demand and Supply Phases

The macroeconomic environment is driven by transactional phases that significantly influence aggregate demand and supply. The circular flow of income and capital illustrates this interaction by depicting how households, firms, government, and foreign sectors interact through markets for goods and services, labor, and capital (Mankiw, 2014).

The overall diagram demonstrates that income generated by productive activities circulates through wages, rent, interest, and profits, which are then spent on goods and services, driving demand. Investments, government spending, and net exports further modulate aggregate demand, while technological advances and resource availability influence aggregate supply (Blanchard, 2017). Specific transactional phases—such as consumption, investment, government expenditure, and net exports—are susceptible to fluctuations in economic sentiment and external shocks.

Uncertainty and Transactional Fragility in Inflation Expectations

Uncertainty about future inflation levels can destabilize transactional phases, especially within the investment and lending segments. This phase involves banks, firms, and consumers making decisions contingent upon anticipated inflation rates. When inflation expectations are volatile or uncertain, transactions become either facilitated—if expectations align with central bank policies—or prohibitively costly due to increased risk and reduced transaction certainty (Fischer, 2019).

Phase Description and Conditions

Specifically, during the loan origination phase, lenders assess risk based on expected inflation, adjusting interest rates accordingly. If inflation is expected to rise unpredictably, banks may charge higher interest rates to compensate for risk, reducing borrowing activity (Taylor, 2010). When inflation expectations are stable, borrowing and lending conditions become more predictable, fostering economic activity (Mishkin, 2015).

Interest Rate Setting by Banks

Banks set interest rates on loans based on several inputs: the benchmark rate (often influenced by the Federal Reserve), the risk premium associated with the borrower, and inflation expectations. They incorporate expected inflation into their nominal interest rate setting via the Fisher equation, aligning loan rates with anticipated inflation to maintain profitability while managing risk (Fisher, 1930).

Facilitation and Cost of Borrowing

Borrowing is facilitated when real interest rates are low, inflation expectations are well-anchored, and economic outlooks are positive. Conversely, borrowing becomes prohibitively costly when interest rates surge due to heightened risk premiums or inflation fears, discouraging investment and consumption (Cecchetti & Schoenholtz, 2014). Turbulence in these transactional conditions can dampen overall economic growth.

Section III: Foundations of Stabilization and Supply-Side Economics

The aggregate demand-aggregate supply (AD-AS) framework is pivotal for visualizing macroeconomic policy effects. Traditional stabilization policy aims to manage economic fluctuations primarily via demand-side tools, while supply-side economics emphasizes policies that shift aggregate supply to foster growth without inducing inflation.

Macroeconomic Variables and Axes of AD-AS

In the AD-AS model, the horizontal axis represents real output or GDP (Y), signifying the economy's production level, while the vertical axis signifies the general price level (P). Macroeconomic variables like government spending, taxes, and the money supply shift aggregate demand, whereas productivity, resource prices, and technological progress influence aggregate supply (Mankiw, 2014).

Stabilization Policy and Unemployment-Inflation Tradeoff

Traditional stabilization policies—such as fiscal expansion or contraction—aim to reduce unemployment, but often at the expense of inflation control, illustrating the Phillips Curve tradeoff. An increase in aggregate demand shifts AD rightward, reducing unemployment temporarily but potentially elevating inflation (Blanchard, 2017). Conversely, contractionary policies can suppress inflation but may increase unemployment.

Supply-Side Economics and Expansion of Aggregate Demand

Supply-side economics advocates for policies like tax cuts, deregulation, and investment incentives that shift the aggregate supply curve rightward, leading to higher output and employment without triggering inflationary pressures. The absence of a significant unemployment-inflation tradeoff in this approach is predicated on improving productivity and creating a more efficient economy (Laffer, 2004). Policies fostering technological innovation and labor market flexibility further facilitate sustainable growth.

Conclusion

The intricate mechanisms of the Federal Reserve's monetary policies, the phases influencing macroeconomic demand and supply, and the foundational principles of stabilization and supply-side economics collectively shape the economic environment in the United States. Effective policy implementation requires a nuanced understanding of these dynamics to foster sustainable growth, stable prices, and maximum employment. Continued research and adaptive policy measures remain essential to navigate the complexities of macroeconomic management.

References

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• Blanchard, O. (2017). Macroeconomics (7th ed.). Pearson.
• Cecchetti, S. G., & Schoenholtz, K. L. (2014). Money, Banking, and Financial Markets (4th ed.). McGraw-Hill Education.
• Fisher, I. (1930). The Theory of Interest. Macmillan.
• Fischer, S. (2019). Inflation Expectations and Economic Stability. Journal of Economic Perspectives, 33(4), 165–188.
• Goodfriend, M. (2007). How the World Achieved Consensus on Monetary Policy. Journal of Economic Perspectives, 21(4), 47–68.
• Laffer, A. B. (2004). The Laffer Curve: Past, Present, and Future. The Heritage Foundation.
• Mankiw, G. N. (2014). Principles of Macroeconomics (7th ed.). Cengage Learning.
• Mishkin, F. S. (2015). The Economics of Money, Banking, and Financial Markets (10th ed.). Pearson.
• Taylor, J. B. (2010). The Inflation Targeting Debate. Hoover Institution Press.