chapter 24 - Chapter The Influence of Monetary and Fiscal...

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Unformatted text preview: Chapter The Influence of Monetary and Fiscal Policy on Aggregate Demand 24 Monetar y Policy I nf luences Aggregat e Demand Aggregat e-demand cur ve slopes downward: The wealth effect The interest-rat e effect The exchange-rat e effect Occur simultaneously: When pr ice level falls Quantity of goods and ser vices demanded increases When pr ice level r ises Quantity of goods and ser vices demanded decreases 2 Monetar y Policy I nf luences Aggregat e Demand For U.S. economy The wealth effect Least impor tant Money holdings a small par t of household wealth The exchange-rat e effect Not large Expor ts and impor ts small fraction of GDP The interest-rat e effect The most impor tant 3 Monetar y Policy I nf luences Aggregat e Demand The theor y of liquidity preference Keyness theor y I nterest rat e adjusts: To br ing money supply and money demand int o balance Nominal int erest rat e Real int erest rat e 4 Monetar y Policy I nf luences Aggregat e Demand The theor y of liquidity preference Money supply Controlled by the Fed Quantity of money supplied Fixed by Fed policy Doesnt var y with interest rate 5 Monetar y Policy I nf luences Aggregat e Demand The theor y of liquidity preference Money demand Money most liquid asset I nt erest rat e oppor tunity cost of holding money Money demand cur ve downward sloping Equilibr ium in the money market Equilibr ium int erest rat e Quantity of money demanded = quantity of money supplied 6 Monetar y Policy I nf luences Aggregat e Demand The theor y of liquidity preference I f interest rate > equilibr ium Quantity of money people want to hold Less than quantity supplied People holding the sur plus Buy int erest-bear ing assets Lowers the int erest rat e People - more willing t o hold money Until: equilibr ium 7 Monetar y Policy I nf luences Aggregat e Demand The theor y of liquidity preference I f interest rate < equilibr ium Quantity of money people want to hold More than quantity supplied People - increase their holdings of money Sell - int erest-bear ing assets I ncrease int erest rat es Until: equilibr ium 8 Figure Equilibrium in the money market 1 9 Interest rate Quantity of Money r 1 Money demand M d 1 According to the theory of liquidity preference, the interest rate adjusts to bring the quantity of money supplied and the quantity of money demanded into balance. If the interest rate is above the equilibrium level (such as at r 1 ), the quantity of money people want to hold (Md 1 ) is less than the quantity the Fed has created, and this surplus of money puts downward pressure on the interest rate. Conversely, if the interest rate is below the equilibrium level (such as at r 2 ), the quantity of money people want to hold (Md 2 ) is greater than the quantity the Fed has created, and this shortage of money puts upward pressure on the interest rate. Thus, the forces of Fed has created, and this shortage of money puts upward pressure on the interest rate....
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chapter 24 - Chapter The Influence of Monetary and Fiscal...

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