Chapter 13 - 6/23/2011 1 Chapter 13 Stabilization Policy...

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Unformatted text preview: 6/23/2011 1 Chapter 13 Stabilization Policy and Charles I. Jones Policy and the AS/AD Framework 13.1 Introduction In this chapter, we learn: With systematic monetary policy, we can combine the IS curve and the MP curve to get an aggregate demand (AD) curve. that the Phillips curve can be reinterpreted as an aggregate supply (AS) curve. how the AD and AS curves represent an intuitive version of the short-run model that describes the evolution of the economy in a single graph. the modern theories that underlie monetary policy. Question for this chapter: If we could formulate a systematic policy in response to the various kinds of shocks that can possibly hit the economy, what would the policy look like? policy look like? 13.2 Monetary Policy Rules and Aggregate Demand The short-run model consists of three basic equations: The model implies that high short-run output leads to an increase in inflation. The central bank chooses how to make The central bank chooses how to make this trade-off by choosing the interest rate. A monetary policy rule a set of instructions that determines the stance of monetary policy for a given situation that might occur in the economy. The rule we consider is that the stance of monetary policy depends on current inflation inflation target If inflation is above the target th l i t t t h ld b hi h the real interest rate should be high. If inflation is below the target the real interest rate should be low. 6/23/2011 2 Inflation Target Current Inflation Simple Monetary Policy Rule Long run Interest Rate Real Interest Rate Governs how aggressively monetary policy responds to inflation The AD Curve We can substitute the monetary policy rule into the IS curve. The resulting equation is the aggregate demand (AD) curve says short-run output is a function of the rate of inflation The AD curve describes how the central bank chooses short-run output based on the rate of inflation. is fundamentally different than market demand. If inflation is above target The central bank raises the interest rate to lower output below potential. Moving Along the AD Curve A change in inflation a movement along the AD curve Changes in alter the slope of the AD curve. 6/23/2011 3 Shifts of the AD Curve AD curve shifts caused by: Changes in the parameter Changes in the target rate of inflation Changes in the target rate of inflation 13.3 The Aggregate Supply Curve The aggregate supply (AS) curve is The price-setting equation used by firms: The Phillips curve with a new name. Equation: Inflation in Current Inflation last time period Parameters The point in the graph where short-run output equals zero is equal to the inflation rate in the previous period....
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This note was uploaded on 08/23/2011 for the course ECON 3203 taught by Professor Robertpennington during the Summer '11 term at University of Central Florida.

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Chapter 13 - 6/23/2011 1 Chapter 13 Stabilization Policy...

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