Class Notes (836,147)
Canada (509,656)
Economics (1,296)
ECN 204 (348)
Lecture

ECN204 Ch15 Notes.docx

5 Pages
113 Views
Unlock Document

Department
Economics
Course
ECN 204
Professor
Christos Shiamptanis
Semester
Fall

Description
ECN204 Ch15 Notes Influence of Monetary and Fiscal Policy on Aggregate Demand Introduction - Short-run effects of fiscal and monetary policy, which work through aggregate demand Aggregate Demand - Recall, AD curve slopes downward for three reason:  Wealth effect  Interest-rate effect  most important of these effects for the economy - Next  Study model that helps explain the interest-rate effect and how monetary policy affects aggregate demand Theory of Liquidity Preference - Simple theory of the interest rate (denoted r) - R adjusts to balance supply and demand for money - Money supply: assume fixed by central bank, does not depend on interest rate - Money demand reflects how much wealth people want to hold in liquid form - For simplicity, suppose household wealth includes only two assets:  Money – liquid buy pays no interest  Bonds – pay interest but not as liquid - A household’s “money demand” reflects its preference for liquidity - Variables that influence money demand: Y, r, and P Money Demand - Suppose real income (Y) rises. Other things equal, what happens to money demand? - If Y rises:  Households want to buy more good & service, so they need more money  To get this money, they attempt to sell some of their bonds - i.e., an increase in causes an increase in money demand, other things equal Active Learning 1 a. Suppose r rises. Other things equal, what happens to money demand?  R is the opportunity cost of holding money  Increase in r reduces money demand: Households attempt to buy bonds to take advantage of the higher interest rate Hence, increase in r causes a decrease in money demand, other things equal b. Suppose P rises. Other things equal, what happens to money demand?  Y is unchanged, people will want to buy the same amount of Good & Service  Since P is higher, they will need more money to do so Hence, increase in P causes an increase in money demand, other things equal How r is Determined - MS curve is vertical:  Changes in r do not affect MS, fixed by BoC - MD curve is downward sloping:  Fall in r increases money demand How Interest-Rate Effect Works Monetary Policy and Aggregate Demand - To Achieve macroeconomic goals, the BoC can use monetary policy to shift AD curve - BoC can change money supply by buying and selling government bonds by conducting open market operations - Changes the interest rate and shift Ad curve Effects of Reducing Money Supply: Closed Economy Active Learning 2 - Determine short-run effects on output - Determine how BoC should adjust money supply and interest rates to stabilize output a. Minister of Finance tries to balance the budget by cutting government spending  Event would reduce aggregate demand and output  Offset this event, the BoC should increase MS and reduce r to increase aggregate demand b. Stock market boom increases household wealth  Event would increase aggregate demand, raising output above its natural rate  Offset this event, the BoC should reduce MS and increase r to reduce aggregate demand c. War breaks out in the Middle East, causing oil prices to soar  Event would reduce aggregate supply, causing output fall  Offset this event, the BoC should increase MS and reduce r to increase aggregate demand Open Economy Considerations - Monetary injection by BoC  Causes dollar to depreciate in value  Dollar depreciation causes net exports to rise  Additional increase in demand for Canadian-produced goods and services not realized in closed economy  Monetary injection in an open economy shifts the aggregate-demand curve farter to the right than in a closed economy  BoC cannot simultaneously choose the size of the money supply and the value of Canadian dollar Monetary Injection in an Open Economy Fiscal Policy and Aggregate Demand - Fiscal policy: setting of the level of government spending and taxation by government policymakers - Expansionary fiscal policy  Increase in G and/or decrease in T  Shifts AD right - Contractionary fiscal policy  Decrease in G and/or increase in T  Shifts AD left - Fiscal policy has two effects on AD 1. Multiplier Effect - If government buys $20B of planes from Boeing, Boeing’s revenue increase by $20b - This distributed to Boeing’s workers (as wages) and owners (as profits or stock dividends) - People are also consumers and will spend a portion of the extra income - Extra consumption cause further increase in aggregate demand  Multiplier effect: additional shifts in AD that result when fiscal policy increase income and thereby increases consumer spending - $20b increase in G initially shifts AD to right by $20b - Increase Y causes C to rise, which shifts AD further to the right Marginal Propensity to Consumer - How big is the multiplier effect?  Depends on how much consumers respond to increase in incomes - Marginal propensity to consumer(MPC):  Fraction of extra income that households consumer rather than save e.g. if MPC = 0.8 and income rises $100, C rises $80 Formula for the Multiplier - Size of multiplier depends on MPC E.g. MPC = 0.5  multiplier = 2 MPC = 0.75 multiplier = 4 MPC = 0.9  multiplier = 10 - Bigger MPC means changes in Y cause bigger changes in C, which in turn cause more changes in Y Other Applications of Multiplier Effect - Multiplier effect:  Each $1 increase in G can generate more than a $1 increase in aggregate demand - Also true for other components of GDP Example: Suppose a recession overseas reduces demand for Canadian net exports by $10b Initially, aggregate demand falls by $10b Fall in Y causes C
More Less

Related notes for ECN 204

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit