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Unformatted text preview: EC 151 Ch: 21 The Influence of Monetary and Fiscal Policy on Aggregate Demand
How monetary policy influences aggregate demand How fiscal policy influences aggregate demand Using policy to stabilize the economy Intro.: Monetary and fiscal policy can influence the aggregate D Change in one of the two policies will cause SR fluctuations in output and P Need to anticipate the effects of the policies so one can, adjust, other policies in response When other things change the aggregate demand policy makers will try to offset the shift of the aggregate D using the tools at their disposal to stabilize the economy How monetary policy influences aggregate demand Aggregate demand downward sloping for 3 reasons the wealth effect the least important effect for U.S. the most important effect for U.S. not very large effect the interest rate effect the exchange rate effect Policy of how IR is determined The theory of liquidity preference the theory of liquidity preference Two assumptions Keynes' theory that the interest rate adjusts to bring money supply and money demand into balance hold expected rate of inflation constant FED controls the MS directly Money demand Q of MS is in the economy is fixed at what ever level FED decides to set it (MS is a vertical line) money is the medium of exchange most liquid asset opportunity cost Equilibrium in the Money Market The downward slope of the aggregate D Summary of the interestrate effect analysis The downward slope of the aggregate D higher P level raises MD higher MD leads to higher IR higher IR reduces the Q of goods and services demanded Negative relationship between P level and the Q of goods and services demanded (illustrated by downward sloping aggregate demand) works the other way around Changes in the MS Changes in the MS When the FED increases the MS, it lowers the IR and increases the quantity of goods and services demanded at any price level, shifting the aggregate demand curve to the right When the fed decreases the MS, it increases the IR and decreases the quantity of goods and services demanded at any price level, shifting the aggregate demand curve to the left The role of the IR target in FED policy Monetary policy can be either described in terms of money supply or in terms of the interest rate Changes in monetary policy aimed to increase aggregate demand could be viewed as increasing the money supply or lowering the IR Changes in monetary policy aimed to decrease the aggregate demand could be viewed as decreasing the money supply or raising the IR Case study: Why the FED watches the stock market (and vice versa) Fiscal policy refers to government's choices regarding the overall level of government purchases or taxes Changes in government purchases How fiscal policy influences aggregate demand the multiplier effect marginal propensity to consume 1/(1MPC) other applications of the multiplier effect How fiscal policy influences aggregate demand Changes in government purchases How fiscal policy influences aggregate demand
the crowding out effect When the government increases its purchases by a certain sum, the aggregate demand for goods and services could rise by more or less than that sum, depending on whether the multiplier or crowding out effect is larger the offset in aggregate demand that results when expansionary fiscal policy raises the interest rates and thereby reduces investment spending How fiscal policy influences aggregate demand Changes in taxes How fiscal policy influences aggregate demand
tax cut shifts the aggregate demand curve to the right
multiplier effect crowding out effect tax increase shifts the aggregate demand to the left How to use policy to stabilize the economy The case for active stabilization policy Case study: Keynesians in the white house The case against active stabilization policy Automatic stabilizers Changes in fiscal policy that stimulate aggregate demand when the economy goes into recession without policymakers having to make any deliberate action The tax system Government spending Not strong enough to prevent recessions ...
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