lec-14a - chapter 34 - the influence of monetary and fiscal policy on aggregate demand.ppt

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Aggregate Demand
policy.
households and business firms
goods and services.

Aggregate Demand
employment.
sometimes used to offset those shifts
and stabilize the economy.

How Monetary Policy Influences

How Monetary Policy Influences
is the interest-rate effect.

The Theory of i!uidity
factors determine the economy&s interest
rate.
ad(usts to balance the supply and
demand for money.

Money "upply
+hanging the reserve re%uirements
+hanging the discount rate

Money "upply
%uantity of money supplied does not
depend on the interest rate.
The fied money supply is represented
by a vertical supply curve.

Money Demand
several factors.
preference, one of the most important
factors is the interest rate.

Money Demand
buy goods and services.

Money Demand
is the interest that could be earned on
interest-earning assets.
the opportunity cost of holding money.
's a result, the %uantity of money
demanded is reduced.

#!uili$rium in the Money
preference: The interest rate ad(usts to balance the
supply and demand for money.
There is one interest rate, called the
e%uilibrium interest rate, at which the
%uantity of money demanded e%uals the
%uantity of money supplied.

#!uili$rium in the Money
The price level is stuc* at some level.
!or any given price level, the interest rate
ad(usts to balance the supply and demand
for money.
aggregate demand for goods and services.

Money supply
r 2
rate

The Downward "lope of the
Aggregate Demand Cur'e
%uantity of money demanded.
of money demanded for any given interest
rate.
interest rate.
demanded falls.

The Downward "lope of the
Aggregate Demand Cur'e
negative relationship between the
and services demanded.

Aggregate
demand
(uantity of )utput
(uantity
$y the Fed
Aggregate Demand Cur'e&&&
Money demand at
1. An increase in the price level…
P 2
r 2

4. …which in turn reduces the quantity of goods and services demanded.
Y 2

Changes in the Money "upply
The !ed can shift the aggregate demand
curve when it changes monetary policy.
'n increase in the money supply shifts
the money supply curve to the right.
Without a change in the money demand
curve, the interest rate falls.
!alling interest rates increase the
%uantity of goods and services demanded.

Y 2
AD 2
3. …which increases the quantity of goods and services demanded at a given price level.
1. When the ed increases the money supply…
MS 2
(uantity
r 2
2. …the equilibrium

Changes in the Money "upply
When the !ed increases the money supply, it
lowers the interest rate and increases the
%uantity of goods and services demanded at any
given price level, shifting aggregate-demand to
the right.
price level, shifting aggregate-demand to the left.

The ,ole of Interest1,ate
Targets in Fed Policy
of the money supply or in terms of the interest
rate.
in terms of a changing target for the interest rate
or in terms of a change in the money supply .
' target for the federal funds rate affects the
money mar*et e%uilibrium, which influences
aggregate demand.

How Fiscal Policy Influences
choices regarding the overall level of
government purchases or taes.
!iscal policy influences saving, investment,
and growth in the long run.
In the short run, fiscal policy primarily
affects the aggregate demand.

Changes in 2o'ernment
supply or taes, the effect on aggregate
demand is indirect / through the spending
decisions of firms or households.
When the government alters its own
purchases of goods or services, it shifts the
aggregate-demand curve directly.

Changes in 2o'ernment
government purchases:

The Multiplier #ffect
multiplier effect on aggregate demand.
1ach dollar spent by the government can
raise the aggregate demand for goods
and services by more than a dollar.

The Multiplier #ffect&&&
!!re!ate demand' AD

1. An increase in government purchases of !2" billion initially increases aggregate demand by !2" billion…
!2" billion
AD 3

A Formula for the "pending
Multiplier
Multiplier , -.(- & M#) 'n important number in this formula is
the marginal propensity to consume
(MPC).
It is the fraction of etra income that a
household consumes rather than saves.

A Formula for the "pending
Multiplier
be:
government spending generates 587
and services.

The Crowding1)ut #ffect
economy as strongly as predicted by the
multiplier.
causes the interest rate to rise.
' higher interest rate reduces

when a fiscal epansion raises the interest
rate is called the crowding-out effect.
The crowding-out effect tends to dampen
the effects of fiscal policy on aggregate
demand.
AD 3
4. …which in turn partly o#sets the initial increase in aggregate demand.
The Crowding1)ut #ffect&&&
!!re!ate demand' AD
(b) The 1hift
Quantit y of
AD 2
230 billion
r 2
MD 2
2. …the increase in spending increases money demand…

purchases by 567 billion, the aggregate
demand for goods and services could rise
by more or less than 567 billion,
depending on whether the multiplier
effect or the crowding-out effect is larger.

Changes in Ta+es
income taes, it increases households&
ta*e-home pay.
income.
consumer goods.

Changes in Ta+es
the multiplier and crowding-out effects.
It is also determined by the households&
perceptions about the permanency of the
ta change.

sing Policy to "ta$ilie the
#conomy
eplicit goal of ".#. policy since the
1mployment 'ct of 94;.

The Case for Acti'e
cause of economic fluctuations.
in the private economy in order to stabilize
aggregate demand.

The Case Against Acti'e
and fiscal policy destabilizes the economy.
Monetary and fiscal policy affect the
economy with a substantial lag.
They suggest the economy should be left
to deal with the short-run fluctuations on
its own.

Automatic "ta$iliers
policy that stimulate aggregate demand
when the economy goes into a recession
without policyma*ers having to ta*e any
deliberate action.
system and some forms of government
spending.

"ummary
preference to eplain determinants of
the interest rate.
rate ad(usts to balance the supply and
demand for money.

"ummary
demand and increases the interest rate.
' higher interest rate reduces investment
and, thereby, the %uantity of goods and
services demanded.
demanded.

"ummary
demand with monetary policy.
ultimately lead to the aggregate-demand
curve shifting to the right.
' decrease in the money supply will
ultimately lead to the aggregate-demand
curve shifting to the left.

"ummary
demand with fiscal policy.
curve to the right.
increase in taes shifts the aggregate-
demand curve to the left.

"ummary
taes, the resulting shift in aggregate
demand can be larger or smaller than the
fiscal change.

"ummary
influence aggregate demand, the government
sometimes uses these policy instruments in an
attempt to stabilize the economy.
1conomists disagree about how active the
government should be in this effort.
olicy advocates say that if the government does not
respond the result will be undesirable fluctuations.
+ritics argue that attempts at stabilization often
turn out destabilizing.

0raphical
<eview
Money supply
r 2
rate

The Money Mar%et and the "lope of the
Aggregate Demand Cur'e&&&
(uantity of )utput
(uantity
$y the Fed
1. An increase in the price level…
P 2
r 2

4. …which in turn reduces the quantity of goods and services demanded.
Y 2
MS 2
Y 1
(uantity
r 2

3. …which increases the quantity of goods and services demanded at a given price level.

The Multiplier #ffect&&&
!!re!ate demand' AD

1. An increase in government purchases of !2" billion initially increases aggregate demand by !2" billion…
!2" billion
AD 3

AD 3
4. …which in turn partly o#sets the initial increase in aggregate demand.
!!re!ate demand' AD
(b) The 1hift
Quantit y of
AD 2
230 billion
r 2
MD 2
2. …the increase in spending increases money demand…

lec-14a - chapter 34 - the influence of monetary and fiscal policy on aggregate demand.ppt

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