Syllabus (Course and Exam Description)

Monetary policies (pp. 82-83)
Monetary Policy Expansionary Contractionary Expansionary Rationale [1] Efficacy
Open-market Operations Buy government bonds Sell government bonds
  1. Buy government bonds by putting money directly into bank reserves.
  2. Total and excess reserves increase.
  3. Demand deposits increase and are lent out.
  4. Money supply increases.
  5. Nominal interest rates fall (via money market)
 Limited reserves
Required reserve ratio Lower it Increase it
  1. Less required reserves
  2. Total reserves stay the same but excess reserves increase
  3. Demand deposits increase and are lent out.
  4. Money supply and multiplier increases.
  5. Nominal interest rates fall (via money market)
 Limited reserves
Administered Interest Rates Interest on reserves Lower it Increase it Lower administered interst rates = lower policy rate (via reserve market) = decrease in other nominal interest rates Ample reserves [2]
Discount rate

Problem: The Liquidity Trap (not tested). Lags with monetary policy:

  1. Time to recognize a problem in the economy
  2. Time for the economy to adjust to the policy action

Footnotes:

  1. Lower interest rates => Less expensive to borrow => More interest-sensitive spending (investment and consumption) => more AD (expansionary). Source: AP Macro 4.6 daily video 1 ↩
  2. Discount rates, the ceiling for policy rates, technically only work under very limited / scarce reserves. In free-response questions about ample reserves, either say "interest on reserves" or "administered interest rates", as just saying "discount rate" will not earn you the point. See the scoring guidelines for 2024 FRQ 1 set 1 and set 2. ↩
Fiscal policies (pp. 67-69)
Fiscal policy Expansionary Contractionary Expansionary rationale
Discretionary Government spending Increase it Increase it Direct impact on AD, scaled by 1/MPS
Taxes Decrease it Increase it Disposable income creates indirect impact on AD (via consumption), scaled by MPC/MPS
Non-discretionary automatic stabilizers Transfer payments (social service programs) Increase it Decrease it Basically negative tax. Same multiplier MPC/MPS. Briefly mentioned in curriculum but tested a lot.
Income taxes - - Offsets recession/inflation to restore long-run equilibrium without having to pass new laws.
Corporate taxes

Problem: crowding out (more overnment spending => deficit => demand for loanable funds => higher real interest rate). Lags with fiscal policy: time to decide on and implement a policy action.