Chapter_11_PartB

Chapter_11_PartB - Recession Depression Expansion and Booms...

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Click to edit Master subtitle style Recession, Depression, Expansion and Booms: The Business Cycle Readings: Zagorsky Book Chapter 11.
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Click to edit Master subtitle style Key Question: What Can Be Done About the Ups and
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Idea of Laissez Faire The Great Depression altered thinking throughout the world. Prior to the early 1930s most economists believed in a laissez faire system. Laissez faire means noninterference in the affairs of others. The central goal of this philosophy is that the government’s regulations and interactions in the nation’s commerce should be the minimum necessary needed in a free-enterprise system. Ex: Mandatory seat belt usage Speed limits
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Opposite of Laissez Faire – Activist Gov. The General Theory of Employment, Interest and Money” (1936). Key point: In periods when the economy is stuck, government intervention using fiscal and monetary policies can eliminate recessions and control economic booms. Keynes is the first major economist who promoted an activist role for government. Government should not play a passive, limited role because economic downturns get out of control.
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Government Has Three Choices The government has three choices it can take when economy slows down or speeds up. Monetary Policy Central bank has the ability to change the money supply and interest rates. These actions in the short run impact the economy. Fiscal Policy Government can change its taxes and expenditure policies. These actions in the medium run have a large impact on the economy. Do nothing (Laissez Faire Approach)
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Monetary Policy Monetary policy is when the Central bank changes either Money supply or Interest rates to influence aggregate demand. To slow economy down Increase interest rates OR decrease money supply To speed economy up Decrease interest rates OR increase the money supply
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What Interest Rate Should Central One method is to use the “Taylor” rule. Central Bank needs to determine actual inflation rate and desired inflation rate. Subtracting (Actual – Desired Inflation) is called the Inflation Gap . Central Bank needs to determine actual GDP growth rate and GDP growth rate that occurs if all resources were employed. Subtracting (Actual – Desired GDP) is called the Output Gap .
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Interest Rate Charged By Central Bank = Inflation rate + Real Interest Rate + ( weight) * Inflation Gap + (1-weight) * Output Gap . Where weight is a number (0 to 100%) that allows the bank to vary how much it cares about inflation versus output. 100% means only care about inflation. 0% means only care about output.
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This note was uploaded on 04/17/2011 for the course EC 102 taught by Professor Zagorsky during the Spring '08 term at BU.

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Chapter_11_PartB - Recession Depression Expansion and Booms...

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