11.11 - NX= 20 T= 250 C: the -400r means: a one percentage...

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Federal Funds Rate- interest rate the fed targets. Interest rate commercial banks charge each other. Therefore, all other interest rates in the market are related to this one. Moving in the same direction but not necessarily in the same proportion. Prime Rate: interest rate banks charge their best customers. Discount Rate: what the fed charges the banks for ___ The fed, by targeting the Fed Funds Rate, can affect all other nominal interest rates in the market. Q. Can the Fed affect the real interest rate? Yes. r = i – pi r = real i rate i = nominal I rate (market i rate) pi= inflation Role of the Fed on stabilizing the economy Before: C=c+mpc(Y-T) Now: (after. affected by the interest rate) C= Why? A higher r means higher saving, less consumption. Planned Investment: I^p A high r: makes it more costly for firms to invest. So, C and I^P are negatively related to the real interest rate. EX. C = 640+.8(Y-T)- 400r I^P= 250-600r G= 300
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Unformatted text preview: NX= 20 T= 250 C: the -400r means: a one percentage increase in the real interest rate reduces consumption by 400*.01 = 40 I^P: a one percentage increase in r: reduces I^P by 600*.01 = 6 Compute the PAE function PAE = [640 + .8(Y-250) -400r] + (250-600r) + 300 + 20 C I^P G NX = [1010 1000r] + .8y ^Autonomous expenditures + ^Induced expenditures If r = 5%, what is the equilibrium level of output in the short-run? PAE = 1010 1000(.05) + .8Y = 960 + .8Y Since PAE = Y Y = 960 +.8Y = 4800 So Y = 4800 Suppose Y* = 5000 (Y*-Y) = 200 = recessionary gap Q. What can the fed do to fight this recessionary gap? Change the interest rate. If the fed changes the interest rate, we know that automatically affects consumption and planned investment. Therefore PAE and output will change. With the multiplier 1/1-mpc = 1/1-.8 = 1/.2 = 5 PAE needs to increase only 4- to increase output 200...
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11.11 - NX= 20 T= 250 C: the -400r means: a one percentage...

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