chapter+9+_15_+11-12-09 - Macroeconomics as a Second...

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Chapter 9 (15): Fiscal and Monetary Policy (v.1 Nov 12 2009) Page 1 of 29 Macroeconomics as a Second Language Chapter 9 (15): Fiscal and Monetary Policy Martha L. Olney [email protected] November 2009 Intro paragraphs Real GDP depends upon aggregate demand – that was Chapter 6’s message. Aggregate demand is the sum of consumption, investment, government and net export spending – that was Chapter 7’s message. Multiplier effects exist: when there is an initial change in aggregate demand, real GDP changes by even more – that was Chapter 8’s message. What are the policy actions that trigger those initial changes in aggregate demand? That is the question for this chapter. In modern developed economies, there are two avenues through which policy actions can change real GDP: fiscal policy and monetary policy. Fiscal policy is spending and taxing. Fiscal policy is conducted by the legislative authorities. Monetary policy is manipulation of the money supply and interest rates. Monetary policy is conducted by the central bank. In the United States, Congress with the approval of the President conducts fiscal policy and the Federal Reserve Board (the Fed) conducts monetary policy. Key terms and concepts Key equations Key graphs When Equilibrium Output is Less Than Full Employment Output
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Chapter 9 (15): Fiscal and Monetary Policy (v.1 Nov 12 2009) Page 2 of 29 In equilibrium, real GDP equals aggregate demand. That was the message of Chapter 6. But nothing about the determination of equilibrium output mentioned full employment. The amount of output that would generate full employment of the labor force is what economists call full-employment output . It is possible for equilibrium output to be less than full-employment output. Equilibrium output does not depend upon whether or not the labor force is fully employed. Equilibrium output depends upon aggregate demand. Remember our “confusion alert” from previous chapters: some textbooks use the phrase “(planned) aggregate expenditures” and hold the phrase “aggregate demand” for later chapters. In those textbooks, they would say equilibrium output “depends upon aggregate demand and aggregate supply.” We will explore these issues in Chapter 12. The full-employment level of output is a hypothetical amount. It is how much output would be produced in the economy in a year if the labor force was fully employed. When the economy is at full employment, then the amount of output equals full-employment output. When the equilibrium level of output is less than full-employment output, economists say there is an output gap or recessionary gap . In Figure 9.1, output in equilibrium is less than full-employment output. The horizontal difference between equilibrium GDP and full-employment GDP equals the size of the output gap.
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chapter+9+_15_+11-12-09 - Macroeconomics as a Second...

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