KRUGMAN_WELLS_MACRO_CHAPTER14

The answer is the supply and demand for loanable

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Unformatted text preview: mand for loanable funds that arise at potential output. In the long run, then, changes in the money supply do not affect the interest rate. So what determines the interest rate in the long run—that is, what determines r1 in Figure 14-14? The answer is the supply and demand for loanable funds. More specifically, in the long run the equilibrium interest rate matches the supply and demand for loanable funds in the loanable funds market that arise at potential output. economics in action International Evidence of Monetary Neutrality These days monetary policy is quite similar among wealthy countries. Each major nation (or, in the case of the euro, group of nations) has a central bank that is insulated from political pressure; all of these central banks try to keep the aggregate price level roughly stable, which usually means inflation of at most 2% or 3% per year. But if we look at a longer period and a wider group of countries, we see large differences in the growth of the money supply. Between 1970 and the present the money supply rose only a few percent per year in some countries, such as Switzerland and the United States, but rose much more rapidly in some poorer countries, such as Bolivia. These differences allow us to see whether it is really true that increases in the money supply lead, in the long run, to equal percentage rises in the aggregate price level. Figure 14-15 on page 364 shows the annual percentage increases in the money supply and in the aggregate price level for a sample of countries over the period 364 PA R T 5 Figure S H O R T- R U N E C O N O M I C F L U C T U AT I O N S UNCORRECTED Preliminary Edition 14-15 Inflation rate, 1970–2000 60% The Long-Run Relationship Between Money and Inflation The horizontal axis shows the annual percent increase in a country’s quantity of money between 1970 and 2000. The vertical axis shows the annual percent increase in a country’s aggregate price level over the same period. Each point represents a specific country. The scatter of points lies close to a 45-degree line, demonstrating that in the long run increases in the quantity of money lead to roughly equal percent increases in the aggregate price level. Bolivia 45-degree line 50 40 30 Switzerland United States 20 10 0 10 20 30 40 50 60% Money supply growth rate, 1970–2000 Source: United Nations Statistical Database. ®® ® ® QUICK REVIEW According to monetary neutrality, changes in the money supply do not affect real GDP or the interest rate, only the aggregate price level. Economists believe that money is neutral in the long run. In the long run, the equilibrium interest rate in the economy is determined in the loanable funds market. It is the interest rate that matches the supply and demand for loanable funds that arise when the economy is at potential output. 1970–2000, with each point representing a country. If the relationship between increases in the quantity of money and changes in the aggregate price level were exact, the points would lie precisely on a 45-degree line. In fact, the relationship i...
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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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