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Lecture_Notes_18 - Fiscal and Monetary Policy Debates...

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Fiscal and Monetary Policy Debates CHAPTER 18
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When you have completed your study of this chapter, you will be able to C H A P T E R C H E C K L I S T Discuss whether fiscal policy or monetary policy is the better stabilization tool. 1
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18.1 FISCAL VERSUS MONETARY POLICY Which tool does the better job of stabilizing short-run economic fluctuations: fiscal policy or monetary policy? We look at three aspects of the fiscal policy versus monetary policy debate: Policy effects Goal conflicts Timing and flexibility
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18.1 FISCAL VERSUS MONETARY POLICY Policy Effects Which policy action has the larger and more predictable effect on aggregate demand: a change in government expenditure or a change in the supply of money? In previous chapters we learned that Investment demand and the demand for money determine the effects of monetary policy and fiscal policy.
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18.1 FISCAL VERSUS MONETARY POLICY The Effects of Monetary Policy The two steps in the transmission of monetary policy are Step 1 : A change in the supply of money influences the interest rate, and Step 2 : A change in the interest rate influences investment and other interest-sensitive components of aggregate expenditure.
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18.1 FISCAL VERSUS MONETARY POLICY The demand for money and investment demand determine whether monetary policy has a powerful or a weak effect. Step 1 : Whether a given increase in the supply of money lowers the interest rate by a lot or a little depends on the sensitivity of the demand for money to the interest rate. Suppose that the quantity of money demanded is relatively insensitive to the interest rate, so a change in the interest rate brings a small change in the quan-tity of money demanded. Then, when the supply of money increases by a given amount, the decrease in the interest rate is large.
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18.1 FISCAL VERSUS MONETARY POLICY In contrast, suppose that the quantity of money demanded is highly sensitive to the interest rate, so even a small change in the interest rate brings a large change in the quantity of money demanded.
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