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AD components Ch33: The four components of AD ： Yd = C + I + G + NX Exogenous change of AD components ： △ C or △ I or △ G or △ NX at any P  horizontal shifts in AD  SR fluctuations in output and employment. Monetary policy ( 貨幣政策 ) and fiscal policy （財政政策） are sometimes used to offset AD shifts & stabilize economy.

Copyright © 2004 South-Western 1. How Monetary Policy influences AD Monetary Policy ：△ M s ，△ r AD slopes downward for 3 reasons: (1) The wealth effect (2) The interest-rate effect (U.S. economy) (3) The exchange-rate effect △ M s : through interest-rate effect  △ AD

Copyright © 2004 South-Western SR: The Theory of Liquidity Preference （流動性偏好理論） Ch34 ： Keynes’ theory of liquidity preference: r adjusts to balance supply & demand for money.  SR theory Ch30 ： P adjusts to balance supply & demand for money.  LR: Price level depends on money supply.

Copyright © 2004 South-Western The Theory of Liquidity Preference Ch29: Money Supply (M s ) is controlled by the CB through: (1) Open-market operations (2) Changing the reserve requirements (3) Changing the discount rate M s fixed by the CB, not depend on r.  M s is vertical.

Copyright © 2004 South-Western The Theory of Liquidity Preference Ch30: Money demand has several determinants: real income (Y), nominal interest rates (R), and the average level of prices (P) in the economy. M d : nominal money demand L: liquidity, L= M d /P = real money demand R= r + π e (π e ： fixed in SR)

Copyright © 2004 South-Western Money Demand (1)money as medium of exchange. Y↑→ L↑  M d ↑. (2) Money, as an asset, opportunity cost of holding money is R. R ↑ (given π e fixed, r↑)  L↓  M d ↓ M d is downward sloping in r.  Ch34: SR (3) As Y and R fixed (L fixed), M d depends on P. As P↑, M d ↑ proportionally.  Ch30: LR

Copyright © 2004 South-Western SR Equilibrium in the Money Market For any given P and Y, r adjusts to balance M s and M d. Fig 34.1: (1)If r = r*, M s = M d. (2)If r > r* (returns on bonds is better), M s > M d. (ES M =ED B ， prefer more bond, less money)  Returns to bond holding r ↓= r*,  M d ↑(movement along M d ): toward equilibrium (3) If r M s  ED M =ES B  r ↑= r*

Fig 34.1 Equilibrium in the Money Market Quantity of Money Interest Rate 0 Money Demand, M d Quantity fixed by the CB Money Supply, M s r2r2 M2M2 d M d r1r1 Equilibrium r* Copyright © 2004 South-Western

Comparative Static 1: The Downward Slope of AD The level of (P, Y) responds to AD ： theory of liquidity preference + interest rate effect to explain why AD slopes downward. Fig 34.2: P↑, M d ↑ ( 右移 ) + given M s fixed  M d > M s ： ED M =ES B (prefer less bond)  new equilibrium r*↑  I↓  Yd↓

Fig 34.2 The Money Market and the Slope of AD Quantity of Money Quantity fixed by the CB 0 Interest Rate M d at P 2, M d at P 1, MsMs (a) The Money Market(b) AD Curve r* increases increases M d Quantity of Output 0 Price Level AD P2P2 Y2Y2 Y P which in turn reduces I and Yd 1. P increases r r2r2 Copyright © 2004 South-Western

Comparative Static 2: Monetary Policy ( △ M s ) Monetary policy by CB: Fig 34.3: M s ↑ ： M s shifts to the right.  M s > M d ： ES M =ED B (prefer more bond)  r*↓  I↑, also C↑and NX↑ (Ch26: r↓, SE>IE  Sp↓and C↑ ) (Ch33: r↓  NCO↑  depreciation  NX↑)  AD shifts to the right (Yd↑ at any given P)  Y↑ (P↑, given upward sloping SRAS) Ch34, 35: Gov’t stimulates ( 刺激 ) AD to counter recession.

Figure 34.3 A Monetary Injection MS 2 MS 1 AD Y Y P1P1 Md at P 1 AD 2 Quantity of Money 0 Interest Rate r r2r2 (a) The Money Market (b) AD Curve Quantity of Output 0 Price Level which increases I and Yd r* falls 1. CB increases money supply... Copyright © 2004 South-Western

The Role of Interest-Rate Targets in CB Policy Monetary policy can be described either in terms of the M s or in terms of r. △ CB discount rate  △ M s  money market equilibrium: △ r*  △ AD.

Copyright © 2004 South-Western 2. How Fiscal Policy influences AD Fiscal policy: △ G, △ T (Gov’t surplus=T-G) In LR, Fiscal policy influences S, I, and growth. Ch26: S=I ， S≡ Sp+Sg (Ch32:S=I+NX, given NX) LF market: Gov’t deficit  S↓  r↑  I↓  future K↓  future Y↓ (Growth↓) In SR, fiscal policy primarily affects AD.

Copyright © 2004 South-Western Changes in Government Purchases ( △ G ) Yd =C+I+G+NX When gov’t purchases (G↑), it shifts AD directly. Alternative: △ M s or △ T, effect on AD is indirect —through spending decisions of firms or households. If M s ↑  r*↓  I ↑ and C↑  AD ↑ IfT↓  Household’s C↑( 稍後分析, 仍有爭議 )

Copyright © 2004 South-Western Macro effects from △ G 2 macro effects from △ G: (1)The multiplier effect (2)The crowding-out effect

Copyright © 2004 South-Western (1) The Multiplier Effect 乘數效果 Multiplier effect ： additional shifts in AD that result when expansionary （擴張性） fiscal policy increases income and thereby increases consumer spending. Each dollar spent by govt can raise AD by more than a dollar. Yd =C+I+G+NX G↑: Yd ↑  Yd=Y↑ Keynesian assumes C=a+bY (0<b<1) Y↑  C↑: Yd↑ further

Figure 34.4 The Multiplier Effect Quantity of Output Price Level 0 AD 1 $20 billion AD 2 AD 3 1. An increase in G of $20 billion initially increases AD by $20 billion but the multiplier effect can amplify the shift in AD Copyright © 2004 South-Western

A Formula for Spending Multiplier ( 支出乘數 ) Yd =C+I+G+NX 1st run increase in output/ income: △ Y(1) = △ Yd = △ G Assumes C=a+bY: △ C(1)=b △ Y(1) =b △ G  2nd run increase: △ Y(2) = △ Yd = △ C(1)= b △ G  3rd run: △ Y(3) = △ C(2) = b 2 △ G △ Y= △ Y(1) + △ Y(2)+ △ Y(3)+… = △ G +b △ G + b 2 △ G+… =(1+b+ b 2+… ) △ G = [1/(1-b)] △ G 0 1  △ Y> △ G

Copyright © 2004 South-Western A Formula for the Spending Multiplier △ Y= [1/(1-b)] △ G ， b = Marginal Propensity to Consume (MPC) 邊際消費傾向： fraction of extra income that a household consumes. Multiplier ≡ △ Y/ △ G = 1/(1 -b) =1/(1 - MPC) If the MPC is 0.8, then the multiplier will be: Multiplier = 1/(1 – 0.8) = 5 a $20 billion increase in government spending generates $100 billion of increased demand for goods and services.

Copyright © 2004 South-Western (2) The Crowding-Out Effect 排擠效果 Fiscal policy may not affect the economy as strongly as predicted by the multiplier. Fig 34.5: SR: Y↑→ L↑  M d ↑  r↑  I↓: Yd↓ (LR: G↑  Gov’t deficit  S↓  r↑  I↓)  crowding-out effect: dampen effects of fiscal policy on AD. AD rise by more or less than △ G, depending on whether multiplier effect or crowding-out effect is larger.

Figure 34.5 The Crowding-Out Effect Quantity of Money Quantity fixed by the CB 0 Interest Rate r Md 1 Money supply (a) The Money Market which increases r* the increase in G and Y increases Md Md2d2 Quantity of Output 0 Price Level AD 1 (b) The Shift in AD which in turn partly offsets the initial increase in AD AD 2 AD 3 1. When an increase in G increases AD r2r2 $20 billion Copyright © 2004 South-Western

Changes in Taxes ( △ T ) T↓: Personal income taxes↓  households’ disposable income ( 可支配所得 ) ↓  Households spend some on consumer goods. C↑  AD↑ The size of △ AD from △ T is affected by the multiplier and crowding-out effects. also determined by the households’ perceptions about the permanency （持久性） of the tax change. If households perceive the tax cut is not permanent （短暫減稅，未來仍加稅 ), they may not increase C. --- 爭議之處

Copyright © 2004 South-Western Ch34,Ch36 (Debate1) Using Policy to Stabilize the Economy ？ 世界經濟之戰影片（ Commanding Heights ） Pro: Gov’t should respond to changes in the private economy in order to stabilize AD. –Stabilization Policy (Keynesian: Market Failure ) Against: Monetary and fiscal policy affect the economy with a substantial lag. So attempts at stabilization often turn out destabilizing. The economy should be left to deal with the SR fluctuations on its own. (Classical : Govt’ Failure)

Copyright © 2004 South-Western Automatic Stabilizers ( 自動調節機能 ) Keynesain ： If I↓  AD↓ ， let G↑  restore AD Classical economists believe in Automatic stabilizers: changes in tax system that stimulate AD. eg, Y↓  T↓  Yd 回升 eg, Transfers↑ （救濟金）  C, Yd 回升 Ch33: Adjustment of P e P↓  LR: P e ↓ Fig 33.8: SRAS 右移  Y↑=Y f

Copyright © 2004 South-Western Ch33 複習 : Shifts in AD Shifts in AD Fig 33.8: AD↓ + SRAS  SR: P↓, Y↓  LR: P e ↓=P↓  SRAS shifts to the right  P↓, Y↑=Y f In LR, shifts in AD affect P but not Y.

Copyright © 2004 South-Western Figure 33.8 A Contraction in AD Quantity of Output Price Level 0 SRAS LRAS AD A P Y AD 2 SRAS 2 1. A decrease in AD causes output to fall in the short run but over time, the SRAS shifts and output returns to its natural rate. CP3P3 B P2P2 Y2Y2 Copyright © 2004 South-Western

Summary Ch26 ， LF Market S and I  LR ： r Ch34 ， theory of liquidity preference M s and M d  SR ： r Ch30 ， M s and M d  LR ： P Ch34: AD downward sloping (SR r effect): P↑  M d ↑  r↑  I↓  Yd↓

Copyright © 2004 South-Western Summary Because monetary and fiscal policy can influence AD, the govt sometimes uses these policy instruments to stabilize the economy. AD↑  Y↑ ( 附帶 P↑) 1. M s ↑  r↓  I↑ （ C↑)  AD↑ 2. G↑(T↓)  AD↑ with multiplier effect and crowding out effect Alternative: Contraction policy ( 緊縮性政策 ): M s ↓or G↓or T↑  AD↓  P↓ ( 平穩物價, 附帶 r↑,Y↓) 2006/6 通膨來襲，美日歐拉警報 2007/5 中國大陸緊縮雙率政策