Week 11_The Influence of Monetary and Fiscal Policy on Aggregate Demand_Official

7/24/2019 Week 11_The Influence of Monetary and Fiscal Policy on Aggregate Demand_Official

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2007 Thomson South-Western, all rights reserved

N. GREGORY MANKIW

PowerPointSlides

by Ron Cronovic

The Influence of Monetary andThe Influence of Monetary and

Fiscal Policy on Aggregate DemandFiscal Policy on Aggregate Demand21


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2C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

In tis c%&ter' loo( )or te %nswers to

tese *+estions,

How does the interest-rate ee!t he"# e$#"ain the

s"o#e o the a%%re%ate-de&and !'r(e)

How !an the !entra" *an+ 'se &onetar, #o"i!, to

shit theAD!'r(e)

In what two wa,s does is!a" #o"i!, ae!t

a%%re%ate de&and)

hat are the ar%'&ents or and a%ainst 'sin%

#o"i!, to tr, to sta*i"i.e the e!ono&,)


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/C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

Introduction

Ear"ier !ha#ters !o(ered0

1 the "on%-r'n ee!ts o is!a" #o"i!,on interest rates in(est&ent e!ono&i! %rowth

1 the "on%-r'n ee!ts o &onetar, #o"i!,

on the #ri!e "e(e" and in"ation rate

This !ha#ter o!'ses on the short-r'n ee!ts

o is!a" and &onetar, #o"i!,

whi!h wor+ thro'%h a%%re%ate de&and3


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Aggregate Demand

Re!a"" theAD!'r(e s"o#es downward or three

reasons0

1 the wea"th ee!t1 the interest-rate ee!t

1 the e$!han%e-rate ee!t

Ne$t0 a s'##",-de&and &ode" that he"#s e$#"ain

the interest-rate ee!t and how &onetar, #o"i!,

ae!ts a%%re%ate de&and3

the &ost iortanto these ee!ts or

the U3S3 e!ono&,


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5

The Theory of Liquidity Preference

6e,nes de(e"o#ed the theory of liquidity

preference in order to e$#"ain what a!torsdeter&ine the e!ono&,7s interest rate3

A!!ordin% to the theor, the interest rate ad8'sts

to *a"an!e the s'##", and de&and or &one,3


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9

The Theory of Liquidity Preference

Mone, S'##",

1 The &one, s'##", is controlled by te -edthro'%h0

- O#en-&ar+et o#erations

- Chan%in% the reser(e re:'ire&ents- Chan%in% the dis!o'nt rate

1 ;e!a'se it is i$ed *, the Fed the :'antit, o&one, s'##"ied does not de#end on the

interest rate31 The i$ed &one, s'##", is re#resented *, a

vertic%l s+&&ly c+rve.


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>

The Theory of LiquidityPreference

I the interest rate is %bovethe e:'i"i*ri'& "e(e" ?s'!h as at r@ the :'antit, o &one,

#eo#"e want to ho"d ?Md@ is "ess than the :'antit, the Fed has !reated and this s+r&l+so) oney &+ts downw%rd &ress+re on te interest r%te3 Con(erse", i the interest rate

is belowthe e:'i"i*ri'& "e(e" ?s'!h as at r2 the :'antit, o &one, #eo#"e want to ho"d

?Md2 is %reater than the :'antit, the Fed has !reated and this sort%1e o) oney &+ts

+&w%rd &ress+re on te interest r%te3

C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY


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BC!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

Money Demand

S'##ose rea" in!o&e ?Y rises3 Other thin%s

e:'a" what ha##ens to &one, de&and)

I Yrises0

1 Ho'seho"ds want to b+y ore %sso the, need ore &one,3

1 To %et this &one, the, attet to se"" so&e otheir *onds3

I.e. an in!rease in Y!a'sesan in!rease in &one, de&and other thin%s e:'a"3


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AACCTTIIVVE LE LEEAARRNNIINNGG 11

The determinant! of money demandThe determinant! of money demand

A. S'##ose rrises *'t Yand Pare 'n!han%ed3hat ha##ens to &one, de&and)

2. S'##ose Prises *'t Yand rare 'n!han%ed3

hat ha##ens to &one, de&and)

@


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An!"er!An!"er!

A. S'##ose rrises *'t Yand Pare 'n!han%ed3hat ha##ens to &one, de&and)

ris the o##ort'nit, !ost o ho"din% &one,3

An in!rease in rred'!es &one, de&and0Ho'seho"ds attet to *', *onds to ta+e

ad(anta%e o the hi%her interest rate3

Hen!e an in!rease in r!a'ses a de!rease in&one, de&and other thin%s e:'a"3

@@


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An!"er!An!"er!

2. S'##ose Prises *'t Yand rare 'n!han%ed3hat ha##ens to &one, de&and)

I Yis 'n!han%ed #eo#"e wi"" want to *', the

sa&e a&o'nt o %s3Sin!e Pis hi%her the, wi"" need &ore &one,

to do so3

Hen!e an in!rease in P!a'ses an in!rease in&one, de&and other thin%s e:'a"3

@2


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@/C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

#o" r I! Determined

MS!'r(e is (erti!a"0

Chan%es in rdo not

ae!t MS whi!h is

i$ed *, the Fed3MD!'r(e is

downward s"o#in%0

a a"" in rin!reases

&one, de&and3

M

Interestrate MS

MD@

r3

'antit, i$ed*, the Fed

E:7&interest

rate


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@4C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

#o" the Intere!t$Rate E%ect &or'!

Y

P

M

Interestrate

AD

MS

MD@

MD2

P4

P3

Y3 Y4

r4

r3

A a"" in Pred+ces oney de%nd whi!h lowersr3

A a"" in rincre%sesIand the :'antit, o %s de&anded3


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Monetary Po(icy and AggregateDemand

To a!hie(e &a!roe!ono&i! %oa"s the Fed !an 'se

onet%ry &olicy to si)t teADc+rve3

The Fed7s #o"i!, instr'&ent is the oney s+&&ly3

The news oten re#orts that the Fed tar%ets the

interest rate31 &ore #re!ise", the )eder%l )+nds r%te= whi!h

*an+s !har%e ea!h other on short-ter& "oans

To !han%e the interest rate and shit theAD!'r(ethe Fed !ond'!ts o&en %r(et o&er%tions

to c%n1e te oney s+&&ly3


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The E%ect! of Reducing the Money)u**(y

Y

P

M

Interestrate

AD@

MS@

MD

P3

Y3

r3

MS2

r4

AD2

Y4

The Fed !an raise r*, red'!in% the &one, s'##",3

An in!rease in rred'!es the :'antit, o %s de&anded3


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AACCTTIIVVE LE LEEAARRNNIINNGG ++

E,erci!eE,erci!e

For ea!h o the e(ents *e"ow -deter&ine the short-r'n ee!ts on o't#'t

-deter&ine how the Fed sho'"d ad8'st the &one,

s'##", and interest rates to sta*i"i.e o't#'t

A. Con%ress tries to *a"an!e the *'d%et *, !'ttin%

%o(t s#endin%3

2. A sto!+ &ar+et *oo& in!reases ho'seho"dwea"th3

C. ar *rea+s o't in the Midd"e East

!a'sin% oi" #ri!es to soar3 @<


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An!"er!An!"er!

A. Con%ress tries to *a"an!e the *'d%et *,!'ttin% %o(t s#endin%3

This e(ent wo'"d red'!e a%% de&and and

o't#'t3To oset this e(ent the Fed sho'"d in!rease

MSand red'!e r to in!rease a%% de&and3

@>


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An!"er!An!"er!

2. A sto!+ &ar+et *oo& in!reases ho'seho"dwea"th3

This e(ent wo'"d in!rease a%% de&and

raisin% o't#'t a*o(e its nat'ra" rate3To oset this e(ent the Fed sho'"d red'!e MS

and in!rease r to red'!e a%% de&and3

@B


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An!"er!An!"er!

C. ar *rea+s o't in the Midd"e East!a'sin% oi" #ri!es to soar3

This e(ent wo'"d red'!e a%% s'##",

!a'sin% o't#'t to a""3To oset this e(ent the Fed sho'"d in!rease

MSand red'!e r to in!rease a%% de&and3

2


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2@C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

-i!ca( Po(icy and AggregateDemand

-isc%l &olicy0 the settin% o the "e(e" o %o(t

s#endin% and ta$ation *, %o(t #o"i!,&a+ers

E5&%nsion%ryis!a" #o"i!,

1 an in!rease in Gandor de!rease in T

1 shitsADri%ht

Contr%ction%ryis!a" #o"i!,

1 a de!rease in Gandor in!rease in T1 shitsAD"et

Fis!a" #o"i!, has two ee!ts onAD3


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The Mu(ti*(ier E%ect

I the %o(t *',s G2* o #"anes ro& ;oein%

;oein%7s re(en'e in!reases *, G2*3 This is distri*'ted to ;oein%7s wor+ers ?as wa%es

and owners ?as #roits or sto!+ di(idends3

These #eo#"e are a"so !ons'&ers and wi"" s#enda #ortion o the e$tra in!o&e3

This e$tra !ons'tion !a'ses 'rther in!reases

in a%%re%ate de&and3

M+lti&lier e))ect0 the additiona" shits inAD

that res'"t when is!a" #o"i!, in!reases in!o&e

and there*, in!reases !ons'&er s#endin%

M+lti&lier e))ect0 the additiona" shits inAD

that res'"t when is!a" #o"i!, in!reases in!o&e

and there*, in!reases !ons'&er s#endin%


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2/C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

The Mu(ti*(ier E%ect

A G2* in!rease in Ginitia"", shitsAD

to the ri%ht *, G2*3

The in!rease in Y!a'ses Cto rise

whi!h shitsAD

'rtherto the ri%ht3

Y

P

AD@

P3

AD2AD/

Y3 Y#Y4

G2 *i""ion


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Margina( Pro*en!ity to Con!ume

How *i% is the &'"ti#"ier ee!t)

It de#ends on how &'!h !ons'&ers res#ond toin!reases in in!o&e3

M%r1in%l &ro&ensity to cons+e 6MPC70

the ra!tion o e$tra in!o&e that ho'seho"ds!ons'&e rather than sa(e

E.g3 i MPC 3> and in!o&e rises G@

Crises G>3


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Notation0 Gis the !han%e in G

Yand Care the '"ti&ate !han%es in Yand C

Y C I G NX identit,

Y C G Iand NXdo not !han%e Y MPC Y G *e!a'se C MPC Y

so"(ed or Y@

@ = MPC

Y

G

A -ormu(a for the Mu(ti*(ier

The multiplier


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The si.e o the &'"ti#"ier de#ends on MPC3

e.g3 i MPC 35 &'"ti#"ier 2

i MPC 3


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2


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2>C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

The Cro"ding$.ut E%ect

Fis!a" #o"i!, has another ee!t onAD

that wor+s in the o##osite dire!tion3

A )isc%l e5&%nsion shitsADto te ri1t

*'t a"so r%isesr *

whi!h red'!es in(est&ent and th'sred+ces te net incre%se in a%% de&and3

So the si.e o theADshit &a, *e s&a""er than

the initia" is!a" e$#ansion3

This is !a""ed the crowdin18o+t e))ect3


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2BC!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

#o" the Cro"ding$.ut E%ect &or'!

Y

P

M

Interestrate

AD@

MS

MD2

MD@

P3r3

r4

A G2* in!rease in Ginitia"", shitsADri%ht *, G2*

;'t hi%her Yin!reases MDand r whi!h red'!esAD3

AD/AD2

Y3 Y4

G2 *i""ion

Y#


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/C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

Change! in Ta,e!

A ta$ !'t in!reases ho'seho"ds7 ta+e-ho&e #a,3

Ho'seho"ds res#ond *, s#endin% a #ortion o this

e$tra in!o&e shitin%ADto the ri%ht3

The si9e o) te si)t is ae!ted *, the +lti&lier

%nd crowdin18o+t e))ects3

Anoter )%ctor0 whether ho'seho"ds #er!ei(e the

ta$ !'t to *e te&or%ry or &er%nent3

1 A #er&anent ta$ !'t !a'ses a *i%%er in!reasein C= and a *i%%er shit in theAD!'r(e =

than a teorar, ta$ !'t3


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AACCTTIIVVE LE LEEAARRNNIINNGG //

E,erci!eE,erci!e

The e!ono&, is in re!ession3Shitin% theAD!'r(e ri%htward *, G2*

wo'"d end the re!ession3

A. I MPC 3> and there is no !rowdin% o'thow &'!h sho'"d Con%ress in!rease G

to end the re!ession)

2. I there is !rowdin% o't wi"" Con%ress need to

in!rease G&ore or "ess than this a&o'nt)

/@


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An!"er!An!"er!



A. I MPC 3> and there is no !rowdin% o'thow &'!h sho'"d Con%ress in!rease G

to end the re!ession)

M'"ti#"ier @?@ = 3> 5

In!rease G*, G4*

to shit a%% de&and *, 5 $ G4* G2*3

/2


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An!"er!An!"er!



2. I there is !rowdin% o't wi"" Con%ress need toin!rease G&ore or "ess than this a&o'nt)

Crowdin% o't red'!es the ia!t o GonAD3

To oset this Con%ress sho'"d in!rease G*,a "ar%er a&o'nt3

//

-i!ca( Po(icy and Aggregate


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/4C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

-i!ca( Po(icy and Aggregate)u**(y

Most e!ono&ists *e"ie(e the short-r'n ee!ts o

is!a" #o"i!, %inlywor+ thro'%h %11 de%nd.

;'t )isc%l &olicy i1t %lso %))ect %11 s+&&ly3

Re!a"" one o the Ten Prin!i#"es ro& Cha# @0People respond to incentives.

A !'t in the ta$ rate %i(es wor(ers incentive towor( ore so it &i%ht incre%sethe :'antit, o

%s s'##"ied and shitASto te ri1t3

Peo#"e who *e"ie(e this ee!t is "ar%e are !a""ed/S+&&ly8siders.0

-i!ca( Po(icy and Aggregate


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-i!ca( Po(icy and Aggregate)u**(y

Govt &+rc%ses %y %lso %))ect %11 s+&&ly0

S'##ose %o(t in!reases s#endin% on roads

?or other &+blic c%&it%l3

;etter roads &a, in!rease b+siness

&rod+ctivity whi!h incre%ses te *+%ntity o)

1:s s+&&lied' si)tsASto te ri1t3

This ee!t is #ro*a*", &ore re"e(ant in the "on%

r'n as it ta+es ti&e to *'i"d the new roads and#'t the& into 'se3


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0!ing Po(icy to )tai(i2e the Economy

Sin!e the E"o,&ent A!t o @B49 e!ono&i!

sta*i"i.ation has *een a %oa" o U3S3 #o"i!,3

E!ono&ists de*ate how a!ti(e a ro"e the %o(t

sho'"d ta+e to sta*i"i.e the e!ono&,3

The Ca!e for Acti3e )tai(i2ation


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/


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/>C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

The Ca!e for Acti3e )tai(i2ationPo(icy

Pro#onents o %ctive st%bili9%tion &olicy

believe te 1ovt so+ld +se &olicyto red'!e these "'!t'ations0

1 when G;P )%lls *e"ow its nat'ra" rate

sho'"d 'se e5&%nsion%ry onet%ry or )isc%l&olicyto #re(ent or red'!e a re!ession

1 when G;P rises a*o(e its nat'ra" ratesho'"d 'se contr%ction%ry &olicy to #re(ent or

red'!e an in"ationar, *oo&


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/BC!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

4eyne!ian! in the &hite #ou!e

@B9@0

ohn F 6enned, #'shed or at%5 c+t to sti+l%te %11 de%nd3

Se(era" o his e!ono&i! ad(isors

were o""owers o 6e,nes3

2@0

Jeor%e ;'sh #'shed or a

t%5 c+t that he"#ed the e!ono&,

re!o(er ro& a re!ession that

had 8'st *e%'n3

The Ca!e Again!t Acti3e )tai(i2ation


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The Ca!e Again!t Acti3e )tai(i2ationPo(icy

Monet%ry &olicy %))ects econoy wit % lon1

l%101 ir&s &a+e in(est&ent #"ans in ad(an!e

so Ita+es ti&e to res#ond to !han%es in r

1 &ost e!ono&ists *e"ie(e it ta+es at "east9 &onths or &on #o"i!, to ae!t o't#'t ande"o,&ent

-isc%l &olicy %lso wor(s wit % lon1 l%10

1 Chan%es in Gand Tre:'ire A!ts o Con%ress31 The "e%is"ati(e #ro!ess !an ta+e &onths or ,ears3

The Ca!e Again!t Acti3e )tai(i2ation


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4@C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

The Ca!e Again!t Acti3e )tai(i2ationPo(icy

;+e to tese lon1 l%1s

!riti!s o a!ti(e #o"i!, ar%'e that s+c &olicies%y dest%bili9e te econoy r%ter t%n el&

it0

;, the ti&e the #o"i!ies ae!t a%% de&andthe e!ono&,7s !ondition %y %ve c%n1ed3

These !riti!s !ontend that #o"i!,&a+ers sho'"d

o!'s on lon18r+n 1o%ls "i+e e!ono&i! %rowthand "ow in"ation3


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Automatic )tai(i2er!

A+to%tic st%bili9ers0

c%n1es in )isc%l#o"i!, that sti&'"atea%% de&and when e!ono&, %oes into re!ession

wito+t#o"i!,&a+ers ha(in% to ta+e an,

deliber%te %ction


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4/C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

Automatic )tai(i2er! E,am*(e!

The ta$ s,ste&

1 Ta$es are tied to e!ono&i! a!ti(it,3hen e!ono&, %oes into re!ession

t%5es )%ll %+to%tic%lly3

1 "is sti+l%tes %11 de%nd %nd red+ceste %1nit+de o) )l+ct+%tions3


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Automatic )tai(i2er! E,am*(e!

Jo(t s#endin%

1 In a re!ession in!o&es a"" and'ne"o,&ent rises3

1 More &eo&le %&&ly )or &+blic %ssist%nce

?e.g.,'ne"o,&ent ins'ran!e we"are31 Govt o+tl%ys on these #ro%ra&s a'to&ati!a"",

incre%se whi!h sti&'"ates %11 de%nd %nd

red+ces te %1nit+de o) )l+ct+%tions3


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C.NCL0)I.N

Po"i!,&a+ers need to !onsider a"" the ee!ts o

their a!tions3 For e$a"e

1 hen Con%ress c+ts t%5es it needs to!onsider the sort8r+n e))ects on a%% de&and

and e"o,&ent and the lon18r+n e))ectson sa(in% and %rowth3

1 hen the Fed red'!es te r%te o) oney1rowt it &'st ta+e into a!!o'nt not on", the

"on%-r'n ee!ts on in"ation *'t the short-r'n

ee!ts on o't#'t and e"o,&ent3


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C!AP"ER S


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4


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4>C!AP"ER #$ THE INFLUENCE OF MONETARY AND FISCAL POLICY

C!AP"ER S


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C!AP"ER S

Week 11_The Influence of Monetary and Fiscal Policy on Aggregate Demand_Official

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Transcript of Week 11_The Influence of Monetary and Fiscal Policy on Aggregate Demand_Official