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Lecture 7

ECON 203 Lecture Notes - Lecture 7: European Central Bank, Money SupplyPremium

3 pages115 viewsFall 2016

Course Code
ECON 203

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Fiscal Policy
Recessionary Gap- raise government spending or cut taxes (expansionary)
- Buy more goods at higher prices, demand for $ goes up
- Increase in interest rates more foreigners want to put money in $
o Value of $ goes up- hurts exporters, helps importers
- AD’’ chokes of AD’ growth because we decrease our net exports
o Kickback gets bigger as US economy gets more integrated
- “As the US economy becomes more globalized, fiscal policy becomes a weaker tool”
Inflationary Gap- lower government spending or raise taxes (contractionary)
- Buy fewer goods, prices are lowered- demand for $ falls and so does the interest
rate value of currency goes down
- Increase in net exports because of weaker dollar- creates inflation by going to AD’’
Need larger amounts of fiscal policy to get the same effect as the past- hurts long term economic growth
Monetary Policy
Inflationary Gap- Fed sells bonds banks call in loans
- Decreases money supply, raise interest rates to choke off investment
- Buy fewer goods at lower prices- demand for $ falls
o Interest rates actually decrease a little bit because shift in money supply is
larger than the shift in money demand
- More people want dollars, fewer americans want to dump dollars- value increases-
net exports decreasing decreases us to AD’
- “As US economy becomes more globalized, monetary policy becomes a stronger
tool.” 25% of economy is importing and exporting- do not need as much policy to
change the economy
Recessionary Gap- Fed buys bonds banks give out loans (expansionary)
- Increase in money supply
- Reduce interest rates to incentivize investment
o Have to make sure it is good investment- cannot just have people building
houses like we did in 2001
- Increase money demand- interest rates raise a little bit
- Lower interest rates- fewer foreigners want it, Americans dump currency- value of $
falls cheaper dollar, increases net exports, increases AD
- Increase AD- lower interest rates, lower value of $, export more things abroad
General Equilibrium Theory- The reason that the dollar appreciates is because the European Central Bank
is depreciating the Euro faster than we are depreciating the dollar monetary policy doesn’t really work
in this case
Recessionary Gap
- Self-correction: increase AD- wages are shifted down as workers are put on sale
- Fiscal: cutting taxes, raising government spending
- Monetary- buying bonds
Pros of Expansionary Fiscal Policy
1. Quick fix
2. Lowers unemployment
3. Politically connected do well- increases the politicians power
4. Helps importers and creditors- interest rates are higher, value of $ is higher
Cons of Expansionary Fiscal Policy
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