Impact of Monetary and Fiscal Policies on Interest Rates and Business Investment Spending Interest Rates Expansionary Monetary Policy Increase supply of money decrease increase Expansionary Fiscal Policy Increase demand for money increase decrease Contractionary Monetary Policy Decrease supply of money increase decrease Contractionary Fiscal Policy Decrease demand for money decrease increase Effect of an increase in G or decrease in T Effect of a decrease in G or increase in T Initially at Full Employment Initially at Full Employment AD 1 PL 2 PL 1 Price Level Y F Y 2 Real GDP LRAS SRAS AD 1 PL 1 PL 2 Price Level Y 2 Y F Real GDP LRAS SRAS AD 2 AD 2 Effect of a supply-side shock: Effect of an increase in G and T of same amount: * Initially at Full Employment Initially at Full Employment Balanced budget increase in G and T is expansionary. AD PL 2 PL 1 Y 2 Y F Real GDP Price Level SRAS 2 LRAS SRAS 1 AD 1 PL 2 PL 1 Price Level Y F Y 2 Real GDP LRAS SRAS AD 2 * If G and T were decreased by the same amount, the effect would be contractionary ( AD
Nonprice Level Determinants of Aggregate Supply and Aggregate Demand C + I + G + Xn = AE AD GDP (Direct relationship between any component of AE and AD and GDP) Factors that Shift AD Curve Factors that Shift the SRAS personal taxes ( Yd) C AD resource availability SRAS corporate income taxes ( profit exp.) I AD WAGES (or any other resource cost) SRAS government spending (exp. Fiscal) G AD New technology SRAS G and T by same amount . G offsets the C. Effect = 1 x G. AD PRODUCTIVITY SRAS profit expectations of businesses I AD government regulation SRAS wealth or consumer indebtedness C AD government subsidies SRAS exports / imports Xn AD business taxes (sales/excises) SRAS $ depreciates Xn AD costs of production SRAS money supply interest rates Net export effect I C Xn AD deficit spending DLF and/or Dm interest rates (i) I AD in personal taxes ( Yd) C AD Supply-side shock ( energy prices) SRAS corporate income taxes ( profit exp.) I AD resource availability SRAS government spending (contr. Fiscal ) G AD WAGES (or any other resource cost) SRAS G and T by same amount . G offsets the C. Effect = 1 x G. G AD technology SRAS profit expectations of businesses I AD PRODUCTIVITY SRAS wealth or consumer indebtedness C AD government regulation SRAS exports / imports Xn AD government subsidies SRAS $ appreciates Xn AD business taxes (sales/excises) SRAS money supply interest rates Net export effect I C Xn AD costs of production SRAS deficit spending DLF and/or Dm interest rates (i) I AD inflationary expectations wages SRAS INCREASE = SHIFT RIGHT DECREASE = SHIFT LEFT (APPLIES TO BOTH CURVES) Reasons for the inverse relationship between the price level and the quantity of real output purchased (negative slope of the AD curve): Interest rate effect: PL Dm i quantity of I and C (real output purchased) (opposite true if PL) Wealth/Real balances effect: PL purchasing power of wealth/real balances quantity of C Foreign Purchases effect: PL exports (seem more expensive) and imports (seem cheaper) Xn Reason for the positively sloped AS curve (
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