Governments can reach target GNP and control economic cycles by changing money price and availability {monetary policy}| {monetary theory}.
money supply: printing money
Governments can increase or decrease money in circulation {money supply} by printing or not printing money.
money supply: bonds
Governments can sell and buy bonds at fixed interest rates for different periods, such as three-month bonds and thirty-year bonds.
money supply: bank loans
Governments can raise or lower their bank-loan interest rate, the discount rate. If discount rate is lower, banks can charge customers lower loan interest rate, so people borrow more and money in circulation increases.
money supply: reserves
Governments can require banks to keep lower or higher percentages of money to cover loans, by the reserve ratio. If reserve ratio is lower, banks can loan more, people can borrow more, and circulating money increases.
interest rate
Printing money, decreasing discount rate, decreasing reserve ratio, and offering bonds increases money supply. When money supply increases, interest rates decrease, because money is less valuable. When interest rates decrease, money supply increases, because people save less.
Not printing money, increasing discount rate, increasing reserve ratio, and buying bonds decreases money supply. When money supply decreases, interest rates increase, because money is more valuable. When interest rates increase, money supply decreases, because people save more.
government
People receive income from working, spend for personal expenses, and have expectations about economy. Income changes slowly, but spending and expectations can change quickly. Government can affect people's spending and expectations. Government can raise and lower money supply, independently of taxes and spending, because it is the largest and most powerful institution and can incur or pay down debt. See Figure 1.
To stop expansion and inflation, governments increase interest rates and decrease money supply, to encourage saving and discourage borrowing. See Figure 2.
To stop recession, governments decrease interest rates and increase money supply, to encourage spending and encourage borrowing. See Figure 3.
Money passes from person to person {circulation, money}| {money circulation}.
Governments can vary interest rate {discount rate}| at which central bank lends money to commercial banks.
Money-supply and disposable-income increases result in larger increases in spending {multiplier effect, money}|, because increased money passes from person to person, by repeated spending. The multiplier process causes larger GNP increase than original income increase.
money supply
Government controls money supply. Government can change planned national expenditures or savings and so disposable income.
marginal propensities
People save some income and spend rest. Money-supply and disposable-income increases add extra income. People who receive extra income must decide how much to save {marginal propensity to save, multiplier} and how much to spend {marginal propensity to consume, multiplier}. Fraction that people decide to spend is money that goes into circulation. Average marginal propensity to spend is never 100%.
marginal propensities: change
Multiplier effect causes marginal-propensity-to-spend changes to multiply throughout economy.
circulation
Some money-supply or disposable-income increase goes to merchants. Merchants decide how much extra income to save or spend. Some money-supply or disposable-income increase goes to middlemen. Middlemen have marginal propensities to spend. Some money-supply or disposable-income increase goes to producers. Producers have marginal propensities to spend. Some money-supply or disposable-income increase goes to workers and investors. Workers and investors are the people that started the cascade. Some money-supply or disposable-income increase keeps cascading.
If average marginal propensity to spend is high, more people receive significant extra income. If average marginal propensity to spend is low, fewer people receive significant extra income. Typically, extra money is miniscule after ten transaction levels.
transaction velocity
Average marginal propensity to spend determines average number of times currency units change hands {transaction velocity, currency}. Transaction velocity can be ten.
multiplier
For example, people can spend 75% of increased money supply or disposable income for personal consumption, government, or exports and 3% for saving, 20% for taxes including Social Security and Medicare, and 2% for imports. Assume transaction velocity is 10. Income increase x multiplies through economy. Multiplier is sum, over transaction-velocity number, of the cascade of marginal propensities to spend. In this example, multiplier is 0.75 * x + 0.75 * (0.75 * x) + 0.75 * (0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) + 0.75 * (0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * 0.75 * x) = (0.75 + 0.54 + 0.41 + 0.30 + 0.23 + 0.17 + 0.13 + 0.09 + 0.06 + 0.04) * x = 2.8 * x. Number of terms is 10. Terms contribute successively lower values.
multiplier: example
Assume average marginal propensity to spend is 90% = 9/10. For every 10 extra dollars, average person spends 9 dollars and saves 1 dollar. See Figure 1. After 10 people receive remaining money, changes are insignificant, so transaction velocity is 10. Multiplier is approximately 9.
multiplier: USA
USA multiplier is 3 or 4.
multiplier: time
The multiplier process takes three to six months to complete. The multiplier effect makes economic planning difficult for more than two years.
Governments can change required minimum ratio {reserve ratio}| of bank reserves to demand deposits, because money available for loans is amount over minimum percentage of demand deposits {free reserves} {excess reserves}. If amount available for loans is more, interest rate is less, and people take out more loans for higher amounts.
Average number of times currency units change hands {money turnover} is money-supply use rate {transaction velocity, monetary policy}|. It measures economy expansion.
Of two moneys with same denomination, people hoard higher-valued one and circulate lower-valued one {Gresham's law} {Gresham law} (Thomas Gresham).
People spend a fraction of total disposable income {average propensity to consume} (APC) and save a fraction {average propensity to save} (APS). APC + APS equals one, because people must spend or save income.
People consume a fraction of disposable-income increases {marginal propensity to consume, income} (MPC) and save a fraction {marginal propensity to save, income} (MPS). For people, MPC + MPS equals one, because people must spend or save income.
6-Economics-Macroeconomics-Government Actions
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Date Modified: 2022.0225