CLAS 110 Lecture Notes - Lecture 5: Federal Funds Rate, Nominal Rigidity, International Trade
Week 5
● Supply and Demand for Loanable Funds
○What happens when both supply and demand for loanable funds increase?
■ Interest rate and savings/interest go up
● Deficit Spending and Interest Rates
○ Deficit: difference between government spending and government revenue
(from taxes)
○What happens to interest rates if the government engages in deficit spending
(spending more money than it has)?
■ If the government has a deficit it cannot pay for all its spending → has to
borrow (or print money)
■ The interest rate will increase
■ This is called “crowding out” -- higher interest rate means lower
investment by businesses
● Deficit Spending, Interest Rate, and the Great Recession
○If deficit spending increases interest rate, why were they so low during the Great
Recession?
■ Stimulus package (American Recovery and Reinvestment Act) and lower
tax revenues resulted in huge deficit
■ Interest rates fell so much that they were negative
■ A few reasons why this could have happened:
● Demand for loanable funds by businesses fell by more than the
increase due to deficit spending
● The supply of loanable funds by households increased and people
started saving more
● Could have also been a combination of these
● Aggregate Supply and Demand
○We can use model of Aggregate demand and aggregate supply to study how real
GDP and prices are determined.
○We can also use it to think about how business cycles (recession/expansion) are
determined.
○ Aggregate Demand: the total amount of real GDP demanded at different price
levels
■ Represents the relationship between price level and spending in the
economy
GDP = C + I + G + NX
■ All of this is planned spending -- it can only happen if there are enough
goods/service supplies
● The aggregate demand curve is downward-sloping
○ Reason is not the same as the demand curve for an
individual good
find more resources at oneclass.com
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Document Summary
Deficit: difference between government spending and government revenue (from taxes) If the government has a deficit it cannot pay for all its spending has to borrow (or print money) This is called crowding out -- higher interest rate means lower. Deficit spending, interest rate, and the great recession investment by businesses. If deficit spending increases interest rate, why were they so low during the great. Stimulus package (american recovery and reinvestment act) and lower tax revenues resulted in huge deficit. Interest rates fell so much that they were negative. A few reasons why this could have happened: Demand for loanable funds by businesses fell by more than the increase due to deficit spending. The supply of loanable funds by households increased and people started saving more. Could have also been a combination of these. We can use model of aggregate demand and aggregate supply to study how real.
