Presentation on theme: "Monetary and Fiscal Policies"— Presentation transcript:
1 Monetary and Fiscal Policies IMBA Macroeconomics IVJack Wu
2 Short-Run Economic Fluctuation Economic activity fluctuates from year to year.A recession is a period of declining real incomes, and rising unemployment.A depression is a severe recession.Fluctuations in the economy are often called the business cycle.
3 Basic ModelTwo variables are used to develop a model to analyze the short-run fluctuations.The economy’s output of goods and services measured by real GDP.The overall price level measured by the CPI or the GDP deflator.The Basic Model of Aggregate Demand and Aggregate SupplyEconomist use the model of aggregate demand and aggregate supply to explain short-run fluctuations in economic activity around its long-run trend.
4 Aggregate Demand and Supply Curves The aggregate-demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level.The aggregate-supply curve shows the quantity of goods and services that firms choose to produce and sell at each price level.
12 Long-Run Aggregate Supply Curve The Long-Run Aggregate-Supply CurveThe long-run aggregate-supply curve is vertical at the natural rate of output.This level of production is also referred to as potential output or full-employment output.Any change in the economy that alters the natural rate of output shifts the long-run aggregate-supply curve.The shifts may be categorized according to the various factors in the classical model that affect output.
13 Shifts Shifts arising Labor Capital Natural Resources Technological Knowledge
15 Short-Run Aggregate Supply Curve Short-run fluctuations in output and price level should be viewed as deviations from the continuing long-run trends.In the short run, an increase in the overall level of prices in the economy tends to raise the quantity of goods and services supplied.A decrease in the level of prices tends to reduce the quantity of goods and services supplied.
18 Two Causes of Economic Fluctuation Shifts in Aggregate DemandIn the short run, shifts in aggregate demand cause fluctuations in the economy’s output of goods and services.In the long run, shifts in aggregate demand affect the overall price level but do not affect output.An Adverse Shift in Aggregate SupplyA decrease in one of the determinants of aggregate supply shifts the curve to the left:Output falls below the natural rate of employment.Unemployment rises.The price level rises
21 Stagflation Stagflation Adverse shifts in aggregate supply cause stagflation—a period of recession and inflation.Output falls and prices rise.Policymakers who can influence aggregate demand cannot offset both of these adverse effects simultaneously.
22 Policy Responses to Recession Policymakers may respond to a recession in one of the following ways:Do nothing and wait for prices and wages to adjust.Take action to increase aggregate demand by using monetary and fiscal policy.
25 Price and Quantity Demanded The price level is one determinant of the quantity of money demanded.A higher price level increases the quantity of money demanded for any given interest rate.Higher money demand leads to a higher interest rate.The quantity of goods and services demanded falls.The end result of this analysis is a negative relationship between the price level and the quantity of goods and services demanded.
27 Fed’s Monetary Injection The Fed can shift the aggregate demand curve when it changes monetary policy.An increase in the money supply shifts the money supply curve to the right.Without a change in the money demand curve, the interest rate falls.Falling interest rates increase the quantity of goods and services demanded.
29 Impacts of Monetary Policy on Aggregate Demand When the Fed increases the money supply, it lowers the interest rate and increases the quantity of goods and services demanded at any given price level, shifting aggregate-demand to the right.When the Fed contracts the money supply, it raises the interest rate and reduces the quantity of goods and services demanded at any given price level, shifting aggregate-demand to the left.
30 Forms of Monetary Policy Monetary policy can be described either in terms of the money supply or in terms of the interest rate.Changes in monetary policy can be viewed either in terms of a changing target for the interest rate or in terms of a change in the money supply.A target for the federal funds rate affects the money market equilibrium, which influences aggregate demand.
31 Fiscal PolicyFiscal policy refers to the government’s choices regarding the overall level of government purchases or taxes.Fiscal policy influences saving, investment, and growth in the long run.In the short run, fiscal policy primarily affects the aggregate demand.
32 Fiscal Policy: continued When policymakers change the money supply or taxes, the effect on aggregate demand is indirect—through the spending decisions of firms or households.When the government alters its own purchases of goods or services, it shifts the aggregate-demand curve directly.
33 Two Macroeconomic Effects There are two macroeconomic effects from the change in government purchases:The multiplier effectThe crowding-out effect