That is the data support the idea that money is

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Unformatted text preview: sn’t exact, because other factors besides money affect the aggregate price level. But the scatter of points clearly lies close to a 45-degree line, showing a more or less proportional relationship between money and the aggregate price level. That is, the data support the idea that money is neutral in the long run. I <<<<<<<<<<<<<<<<<< >>CHECK YOUR UNDERSTANDING 14-4 1. Assume the central bank increases the quantity of money by 25%, even though the economy is initially in both short-run and long-run macroeconomic equilibrium. Describe the effects, in the short run and in the long run (giving numbers where possible) on the following: a. Aggregate output b. The aggregate price level c. The real quantity of money d. The interest rate Solutions appear at back of book. • A LOOK AHEAD • Monetary and fiscal policy can be used to help close gaps: a recessionary gap, in which the economy is producing less than potential output, or an inflationary gap, in which it is producing more than potential output. We have not yet explained, however, why closing such gaps is so important. In the case of a recessionary gap, the answer is that recessionary gaps are associated with high unemployment. To deepen our understanding of that concern, however, we need to look more deeply into the causes and meaning of unemployment. That’s the subject of Chapter 15. The causes and costs of inflation are a more subtle issue, which we deal with in Chapter 16. UNCORRECTED Preliminary Edition CHAPTER 14 M O N E TA R Y P O L I C Y 365 SUMMARY 1. The money demand curve arises from a trade-off between the opportunity cost of holding money and the liquidity that money provides. The opportunity cost of holding money depends on short-term interest rates, not long-term interest rates. 2. Other things equal, the nominal quantity of money demanded is proportional to the aggregate price level. So money demand can also be represented using the real money demand curve. Changes in real aggregate spending, technology, and institutions also shift the money demand curve. According to the velocity of money approach to money demand, the real quantity of money demanded is proportional to real aggregate spending. 3. The liquidity preference model says that the interest rate is determined in the money market by the money demand curve and the money supply curve. The Federal Reserve can change the interest rate in the short run by shifting the money supply curve. In practice, the Fed uses open-market operations to achieve a target federal funds rate, which other interest rates generally track. 4. Expansionary monetary policy, which reduces the interest rate and increases aggregate demand by increasing the money supply, is used to close recessionary gaps. Contractionary monetary policy, which increases the interest rate and reduces aggregate demand by decreasing the money supply, is used to close inflationary gaps. 5. Like fiscal policy, monetary policy has a m...
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This note was uploaded on 09/09/2009 for the course ECON 701 taught by Professor Charlie during the Spring '09 term at École Normale Supérieure.

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