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cheat sheet - The AD curve shows a negative relationship...

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The AD curve shows a negative relationship between two economic variables: real GDP and inflation. The relationship between the inflation rate and the real interest rate is called the monetary policy rule . When inflation rates rise, the Federal Reserve responds by raising the real interest rates (through a more than proportional increase in the nominal interest rate) and vice versa. Real Interest rate = Nominal Interest Rate minus the expected inflation rate. There is an inverse relationship between real GDP and inflation because an increase in inflation leads to a higher interest rate, which leads to a decrease in real GDP. Movements along the AD curve and shift of the AD curve: A change in real GDP due to a change in inflation is a movement along the aggregate demand curve. Shifts of AD curve can be caused by: Government Purchases (increase in government purchases shifts AD to the right). 2) Inflation Target Rate: A higher inflation target lowers interest rate. AD curve will shift right. A lower inflation target increases interest rate. AD curve will shift left. 3) An increase in net exports, consumption and decrease in taxes will lead to AD curve shifting right. The Inflation Adjustment line is a flat line showing the level of inflation in the economy at any point in time.
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This note was uploaded on 02/13/2012 for the course ECON 2 taught by Professor Staff during the Fall '10 term at Santa Clara.

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