Chapter 21 PP Slides - 4/30/2010 Aggregate Demand Recall,...

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4/30/2010 1 Monetary and Fiscal Policy in the AD/AS Model Material corresponding to Chapter 21 Aggregate Demand Recall, the AD curve slopes downward for three reasons: The wealth effect The interest-rate effect The exchange-rate effect the most important of these effects for the U.S. economy 3 The Theory of Liquidity Preference Money demand reflects how much wealth people want to hold in liquid form. For simplicity, suppose household wealth includes only two assets: Money – liquid but pays no interest 4 Bonds – pay interest but not as liquid A household’s “money demand” reflects its preference for liquidity . How r Is Determined MD curve is downward sloping : A fall in r increases the quantity of mone demanded Interest rate MS r 1 5 money demanded. MS curve is vertical : Changes in r do not affect MS , which is fixed by the Fed. M MD 1 Quantity fixed by the Fed Eq’m interest rate
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4/30/2010 2 Determinants of Money Demand An increase in Y causes an increase in money demand, other things equal. Households want to buy more g&s, so they need more money. To get this money, they attempt to sell some of 6 their bonds. An increase in P also causes an increase in money demand, other things equal. As before, households need more money to purchase g&s that are more expensive Sell bonds to acquire money Monetary Policy and Aggregate Demand To achieve macroeconomic goals, the Fed can use monetary policy to shift the AD curve. The Fed’s policy instrument is MS . The news often reports that the Fed targets the interest rate. 11 More precisely, the federal funds rate – which banks charge each other on short-term loans To change the interest rate and shift the AD curve,
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This note was uploaded on 08/24/2011 for the course ECO 304L taught by Professor Bencivenga during the Spring '10 term at University of Texas at Austin.

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Chapter 21 PP Slides - 4/30/2010 Aggregate Demand Recall,...

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