ECO100Y5 Lecture Notes - Lecture 39: Aggregate Demand, Fiscal Policy, Monetary Policy

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Loanable funds shows the relationship between loanable funds and the long term real interest rate(r). Money market shows the relationship between the quantity of money and short term nominal interest rate (i). r and i frequently moves in the same direction. Foreign investors are going to want to invest in canada and cad appreciates because more demand for cad, which causes decrease in x - increase in m=decrease in nx. Decrease interest rates to increase ad and rgdp - buy bonds. Increase interest rates to decrease ad and rgdp - sell bonds. Fiscal policy is a change in federal taxes and change in gov"t spending that are intended to achieve macroeconomic policy goals. Gov"t borrows during budget deficit and pays back during budget surplus\. Debt= sum of past deficits - sum of past surpluses. Automatic stabilizers - gov"t spending and taxes that automatically adjust with business cycles.

Related Questions

5. Fiscal policy is enacted through changes in

A. interest rates and the price level.

B. the supply of money and foreign exchange.

C. unemployment and inflation

D. taxation and government spending.

6. In an economy, the government wants to decrease aggregate demand by $48 billion at each price level to decrease real GDP and control demand-pull inflation. If the MPS is 0.25, then it could

A. increase taxes by $16 billion.

B. increase taxes by $24 billion.

C. decrease government spending by $10 billion.

D. decrease government spending by $16 billion.

7. If there is a constitutional requirement to maintain a balanced budget, then during a recession when tax revenues are shrinking, the government will have to implement

A. contractionary fiscal policy.

B. no change in fiscal policy.

C. expansionary fiscal policy.

D. countercyclical fiscal policy.

8. Most economists believe that fiscal policy is:

A. better than the monetary policy for "fine-tuning" the economy.

B. better than the monetary policy for month-to-month stabilization.

C. not as good as the monetary policy for month-to-month stabilization.

D. not very good at pushing the economy in a particular direction.

9. An increase in the legal reserve ratio

A. increases the money supply by increasing excess reserves

B. decreases the money supply by decreasing excess reserves

C. increases the money supply by decreasing excess reserves

D. decreases the money supply by increasing excess reserves

10. The discount rate is the rate of interest at which

A. Federal Reserve Banks lend to commercial banks

B. savings and loan associations lend to some builders

C. Federal Reserve Banks lend to large corporations.

D. commercial banks lend to large corporations

11. Which of the following actions by the Fed most likely increase commercial bank lending?

A. raising the reserve ratio

B. increasing the federal funds rate target

C. reducing the interest paid on excess reserves held at the Fed

D. selling bonds to commercial banks and the public

12. Assume the economy is operating at less than full employment. An expansionary monetary policy will cause interest rates to ______, which will ______ investment spending.

A. decrease; decrease

B. decrease; increase

C. increase; increase

D. increase; decrease

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Multiple Choice

1. Assume that the money multiplier equals 2.5 and if the Fed purchases $10 million in bonds from a bank, the monetary supply will:

Increase by $10 million.
Increase by $25 million.
Decrease by $10 million.
Decrease by $25 million.

2. The monetary base is defined as:

all currency in circulation.
checkable deposits at depository institutions.
excess reserves in the banking system.
currency plus total banking reserves.

3. Which of the following means of financing federal government spending will increase the monetary base?

raising the corporate income tax.
raising the personal income tax.
selling bonds to the public.
selling bonds to the Fed.

Short Answer

1. Assume the Federal Reserve Board is undertaking an expansionarymonetary policy. Explain the details of how the expansionary Fed impacts each of the following:

Open market operations - how does the Fed use open market operations for an expansionary monetary policy?
The monetary base.
Money Supply.
Fed funds interest rate.
Long-term interest rates.
Business Investment.
Aggregate demand.
Economic growth.
Unemployment rate.

2. Under certain circumstances, expansionary Fed policy may not have much of an effect on the rate of economic growth. Give a reason why, and explain?

3. Regarding the Asian currency crisis, answer the following questions:

Describe the normal reasons why a currency undergoes a significant depreciation and what were the important characteristics of the Asian countries involved in the crisis?
What are some expected domestic economic consequences of the currency crisis for the countries involved? Focus on:
- import prices of goods and services into the Asian country.
- export prices of goods and services from the Asian country.
- Domestic inflation rates.
Assume that the countries involved undertake a tight monetary policy and raise interest rates in response to the crisis. What are the two primary reasons for raising interest rates in their case?
Given high domestic interest rates, what is the economic outlook for these Asian countries in the next few years?

Using the graph and definitions below of the supply of loanable funds, SLF, and the demand for loanable funds, DLF, discuss the following:

a. What is meant by the equilibrium nominal rate of interest?

b. Illustrate and discuss how an autonomous increase in the expected rate of inflation will change the equilibrium nominal interest rate. Express your discussion in terms of the effect on the supply and demand for loanable funds. Consider an initial real rate of interest of 3 percent and an expected inflation rate of 3 percent. If the expected rate of inflation rises to 4 percent with the real interest rate constant, what would the resulting nominal interest rate become in equilibrium using the Fisher relationship? Assume that investors believe the rise in the expected rate of inflation will remain at the higher level indefinitely.

c. Starting from an equilibrium position as in a, discuss the effects of a tightening monetary policy if the markets believe that a Fed tightening will lower future (next period) inflation. How might a recession occur under this scenario? HINTS: Recall the Fisher relationship where (1+i) = (1+r)(1+pe), where i is the nominal interest rate, r is the required real rate of return before taxes, and pe is the expected rate of inflation.

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ECO100Y5 Lecture Notes - Lecture 39: Aggregate Demand, Fiscal Policy, Monetary Policy

ECO100Y5 Full Course Notes

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