ch29 - Fiscal and Monetary Interactions Macroeconomic...

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Chapter 29 Fiscal and Monetary Interactions Macroeconomic Equilibrium Real GDP and the price level are determined at the intersection of the AD curve and the SAS curve. Aggregate demand is determined by consumption expenditure, investment, government expenditures, and net exports. o Interest-sensitive expenditure depends on the interest rate The interest rate is determined at the intersection of the MS curve and the MD curve. o Monetary policy affects the quantity of money, which in turn results in a change in the interest rate o A change in the interest rate results in a change in interest-sensitive expenditure In the figure, the intersection of the AD curve and the SAS curve determines real GDP at $1,000 billion and the price level at 110.
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When real GDP is $1,000 billion, the demand for money curve is MD . When the price level is 110, the supply of real money curve is MS . The equilibrium interest rate is 5 percent a year. At an interest rate of 5 percent a year, the IE curve gives interest-sensitive expenditure of $100 billion. Monetary policy affects the money supply curve, which in turn results in a change in the interest rate. A change in the interest rate results in a change in interest-sensitive expenditure. A change in interest-sensitive expenditure results in a change in aggregate demand. A change in aggregate demand results in a change in real GDP, and a change in the price level.
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Fiscal Policy in the Short Run A fiscal policy that increases aggregate demand is called an expansionary fiscal policy . Expansionary fiscal policy has: o first round effects o second round effects In the first round, the figure below shows that an increase in government expenditures increases aggregate demand with a multiplier effect.
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