ch9bnotes - Keynesian Analysis Classical Model: w, N, Y, r...

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Keynesian Analysis Classical Model: P r Y N w , , , , determined by Market Forces. Wages, Prices and Interest Rates adjust freely and quickly. Keynesian Analysis is based on the possibility of slow adjustment of Prices, Wages, or both.
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Classical Equilibrium r r Y Y IS FE Other points on IS are not relevant.
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Classical Equilibrium Y G r I r Y C d d = + + ) ( ) , ( Goods Supply exceeds Goods Demand. Suppose that Y G I C d d + + Now what happens? Y adjusts to keep S d = I d . We may wind up at other points on IS . Keynesian Equilibrium Keynesian Analysis is built on the premise that when Y Y d , Real GDP is Demand Determined. Equilibrium with d d I S = is attained through adjustments in Y .
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Keynesian Equilibrium Positions r Y IS 1 r 2 r 1 Y 2 Y Lower Interest Rates Stimulate Aggregate Demand and Therefore Lead to Higher Real GDP, at Least in the Short-Run.
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Alternative Monetary Arrangements Central Bank Controls the Money Supply Central Bank Controls the Real Interest Rate Central Bank Follows Some Other Rule Real Interest Rate Rules Current Arrangement in U.S.: Interest Rate Targeting (Fed Funds Rate) When the Federal Reserve Sets r, Economy Will Be at the Point on the IS Curve at the Target Interest Rate. How Does the FED Hit the Target If r is too High, Buy Gov't Bonds If r is too Low, Sell Gov't Bonds Open Market Operations
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r Y IS Target r * Y Depending on Circumstances, * Y may be Greater Than, Less Than, or Equal to Y . The FR usually Tries to Set the Target So That Y Y * = . FR's Job is Complicated By the Fact That It
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ch9bnotes - Keynesian Analysis Classical Model: w, N, Y, r...

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