Recession Causes Fiscal Shock Fiscal Policy federal spending taxes Rare cause

Recession Causes: Fiscal Shock Fiscal Policy: federal spending & taxes Rare cause Recession Causes: Monetary Policy Shock 1. very rapid growth & real GDP > pot. GDP 2. more inflation likely – more than Fed’s goal 3. Fed slows economy with higher interest rates common cause. Section 4 Aggregate demand (AD) is all spending ( all purchases ) in an economy for different values of the price level (P). Components: C – consumption I – investment G – government purchases NX – net exports (exports - imports) AD = C + I + G + NX Consumption (C; 67% of GDP) def : household disposable income: income – taxes + transfer payments • as disposable income , C • wealth effect: as wealth , C • as interest rates ¯, C • population: more people à C Investment (I; 15% of GDP) • as interest rates ¯, I • as taxes on investment ¯, I • and more firms, I Graphing AD the role of the price level (P) all prices and nominal wages change examples P → real wealth ¯ → C ¯ → AD ¯

P → U.S. exports costs → NX ¯ → AD¯ P → loan demand→i. rates→C & I ¯→AD¯ Government purchases ( G ; 19% of GDP) • independent of taxes (T) • broader concept: federal expenditures = G + transfers + interest payments (on the federal debt) Net Exports (NX; -3% of GDP) • the dollar’s value vs. foreign currencies – its “exchange rate” ( not P) • exports – imports ex : U.S. exports = $2.2 trillion (12%) imports = $2.8 trillion (15%) • if foreign income rises, NX the dollar appreciates à NX ¯ the dollar depreciates à NX ↑ Fiscal policy G , T ¯ (via C & I), transfer pay. (via C) Monetary policy interest rates ¯ (on C & I) All production = aggregate supply (AS) The short run aggregate supply curve (SRAS) shows how much the economy can produce at different values of the price level (P). In general, the price firms sell their final goods for (their production; all firms: P) is more flexible than the cost of their inputs . Wages & some other costs are “ sticky ” – slow to change. SRAS Shifts Types of costs to businesses - costs in general ( like wages & capital ) - energy (oil) prices (sudden change: shock ) - Expected increase in costs due to predicted inflation (i.e. P ) Shift Summary - K, L, or technological change à SRAS right - costs to business (wages, capital, energy) à SRAS left expected inflation à SRAS left SRAS describes what the economy can produce and it clearly cannot be exceeded. Equilibrium is where all spending (AD) equals all production (SRAS). - Equilibrium tells you the values of P & Y . - Economy stays in equilibrium until there is a - shift in a curve, & then get a new equilibrium. - It is used to explain the economy over a few years.

Static Equilibrium - The Fed stimulates the economy. - int. rates ¯ à C & I - P with more spending - P à more production - result: Y & millions - more employed  event, curve shifts, new eq., new P&Y Why are AD and SRAS growing so slowly? Slow Growth in this Expansion 1. financial crisis and housing crisis 2. Fiscal policy (to 2014) G ¯ and T à slower AD 3. Less investment and fewer working (lower pot. GDP) 4. Rise in the value of the dollar – slowed AD Section 5 Monetary and Fiscal Policy Part A: Financial Markets and Assets Financial Assets: A legal claim for future payments  ex: