1. 3.4 Demand and Supply Side Policies

2. 3.4.1 Shift in Aggregate Demand Demand Side Policies  Shifting the AD Curve (changes in any components) C, I, G, X-M –Expectations  Inflationary  Wealth and Income  Profit and Revenue  Policy  Overall Outlook

3. –International Issues  Exhange Rates  Trading Partner’s Income  Relative Prices –Fiscal Policies  Taxes or Govt. Spending –Monetary Policies  Central Bank  Interest Rates and Money Supply

4. AD Short Run Vs. Long Run  AD shift without increase in LRAS is INFLATIONARY  A to B to C  B: Real wages drop, factor prices increase (causes supply shift)  C: Inflationary result

5. Overview of Demand Management  See Chart pg.380  Overheating vs. Recessionary Economy  Problem: Fast rising inflation  Solutions: Monetary?? Fiscal??  Problem: High Unemployment  Solutions: Mon.?? Fisc.??

6. Govt. Budgets  Receipts – Expenditures  Which item under Receipts is the biggest future problem?  Surplus vs. Deficit  National Debt vs. Foreign Debt –Foreign = owed to other countries

7. Built-In Safety Nets vs. Active Policies  Automatic-Stabilisers (Built-In Safety Net) –Progressive Taxes  Expansion: > % income paid = less disposable income= % income paid = less disposable income= < Consumption = < AD  Recession: AD –Social Benefits  Expansion: < Unemployment, Welfare = < Consumption = <AD  Recession: > social spending = >AD Both help to “soften” cycles, less volatile Don’t solve or prevent cycles Graphs pg. 383

8.  Discretionary Fiscal Policies (Active) – Govt. Spending  Expansion: Less spending < AD  Recession: More spending > AD  Focus on Unemployment  Surpluses (Boom) used for > Spending during bad times Does this really happen? –Taxes  Expansion: >Taxes = Taxes =<C = <AD  Recession: C = >AD

9. Interest Rates and Monetary Policy  Definition: –Real Interest = Nominal – Inflation  Ex. 2% real = 5% nominal – 3%inflation  Central Bank –Interest Rates  Influence C and I  Inflation positively linked to interest rates –Review pg. 346  Used to minimize inflation.

10. Functions of Central Bank  Monetary policy- –interest rates, money supply  Lender of Last Resort –To commercial banks –Discount rate  Key for other rates  Affects bank profit and lending rates  Regulate Lending –Minimum reserve requirements

11.  What could the Central Bank (Fed) do to “tighten the money supply”?  When would the Fed do this?  Time Lags –Fed must try to be forward thinking –2-6 quarters to influence inflation –Up to 2yrs to affect AD

12. Relationship between Interest and Investment  Investment Schedule –Lower interest rates= Higher investment –1. Opportunity Costs  Investment increases when opportunity costs fall –2. Cost of Investment  Lower rates = lower cost of borrowing

13. Supply and Demand for Money pg. 388-389  Demand for Money < Dm = shift left= lower r –Caused by factors other than price (r)  Ex. Income levels, price levels (inflation)  Supply of Money –Feds most common methods  Discount Rate –Affects lending ability  Open Market Operations –Buying and Selling of govt. debt  Bills and Bonds  Controls on Bank Lending –Reserve requirements

14.  Final note from text: –Basic Theory:  Change in Sm = Change in r –Vice Versa  Change in r = Change in Sm –Fed Can’t do Both simultaneously

15. Exchange Rate Policies  Can be influenced by Fed (rate change)  Fed raises rates = greater demand for US currency = > currency appreciation = M (foreign goods cheaper) = currency appreciation = M (foreign goods cheaper) = <AD  Falling r = falling currency value –>exports  (U.S. goods cheaper for other countries) –< imports  (foreign goods more expensive)  More on this in 4.6