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# sumassign5 - Intro Macro ASSIGNMENT 5 N Sheflin NOTES We...

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I n t r o M a c r o N . S h e f l i n ASSIGNMENT 5 NOTES : We take a closer look at monetary and fiscal policy in the Keynesian short run model, and a glance at monetary theory (how money ‘matters’). Don’t worry about ( ignore ) reference to long-run policy issues for now. We’ll come back to this in more depth later in the course. Bring your resume to hand in. In addition to having one when the President offers you a position, it will show you if you are doing the right things in college. Also, we’ll play a short run monetary policy game– the Chairman’s game Don’t forget to buy stock in Investment Game Round 1, and make sure to do the reading and study the questions – some of which will appear on the hw. Key points and Summary –read carefully before and after the homework Keynesian Monetary Theory (how the quantity of money (currency + checkable deposits) affects the economy) Basically, the demand and supply of money determines interest rates which determine Investment (in plant and equipment) which is part of and thus changes Aggregate Demand which, given aggregate supply, determine prices and output. Think of interest rates as the ‘price’ of money and so the demand for money curve is downward sloping: Downward sloping Md curve - at a higher interest rate, the quantity demanded of money is lower since the opportunity cost of holding money is higher (the interest you lost by not selling your money in return for an interest earning bond). Keynes called the Md function, the Liquidity Preference curve and spoke of a transactions, precautionary and speculative demand for holding money, the latter responding to interest rates inversely and reflecting the fact that bond prices move inversely to interest rates. An increase in the Money Supply , caused by the Fed, will lower the interest rate (think of the interest rate as the ‘price’ of money). The Money Supply curve is drawn as vertical since the Fed can make the Ms whatever it want – this reflects the intro level assumption that the Ms doesn’t respond to interest rates (in fact, it does and should be upward sloping, but this won’t change anything much). How changes in Ms impact the economy (Monetary transmission Mechanism). There are several channels: Ms=money supply i=Interest rate P=price y=output X=exports M=imports o interest rate effect Ms up-> i down ->I up ->D up ->P,y up

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480 that is: changes in the supply of money, cet.par., reduce interest rates, increases investment and aggregate demand and thus output and prices/inflation o exchange rate effect Ms up-> i down ->\$ down ->X up, Imports down ->D up ->P,y up o wealth effect Ms up-> i down ->Stock Prices up -> W up ->C up ->D up ->P,y up ‘Keynesian’ Short-Run Monetary Policy Fed use of open market operations, discount rate and other policies to stabilize – speed up or slow down the economy to achieve stable prices maximum employment. Recently, the Fed has been undertaking many
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sumassign5 - Intro Macro ASSIGNMENT 5 N Sheflin NOTES We...

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