1. Foreign Capital Budget Deficit Exports PrM H/B Consumption TRSY FxMCrM THE COMPLETE “MONEY” MODEL The FED Cash Change of Money Demand Rest of the World Banks & Credit Fiscal Policy Money The Inner Loop InvestmentGovernment Purchases ImportsSaving (net) Taxes Income Spending LaM wages Profit, interest, rent Change of Money Supply

2. ABBREVIATIONS E I PrM H/B X C Y TRSY T G FxMCrM FS KBB/Def The FED Cash ΔMD ΔMS We will often omit the Labor Market

3. THE COMPLETE CIRCULAR FLOW The BASIC MODEL Y = Income Cd = Domestic Consumption S = Saving I = Investment X = Spending The TREASURY G = Gov’t Purchases T = Net Taxes BB = the budget balance = T – G Def = the Deficit = G – T TP = Transfer Payments The FOREIGN SECTOR F = Imports E = Exports K = Foreign Capital Flows MONEY ΔMD = changes of Money Demand to/from CASH ΔMS = changes of Money Supply to/from the FED Y = Cd + F + S + T X = Cd + E + I + G S + K + ΔMS = I + Def + ΔMD T + Def = G (T = Tgross – TP) F = E + K The “PLACES” H/B = Households and Businesses PrM = The Product Market LaM = the Labor Market CrM = the Credit Market FxM = the Foreign Exchange Market TRSY = the government Treasury CASH = the public demand for money FED = the Federal Reserve

4. E I PrM H/B X C Y TRSY T G FxMCrM FS THE CLOSED MODEL ignores the money variables KBB/Def Sometimes we will ignore ΔMD and/or ΔMS

5. I PrM H/B X C Y TRSY T G CrM S THE TREASURY MODEL BB/Def Often we will ignore the rest of the world The FED ΔMS Cash ΔMD

6. E I PrM H/B X C Y FxMCrM FS THE FOREIGN MODEL K Sometimes we will ignore Fiscal Policy to concentrate on foreign trade The FED ΔMS Cash ΔMD

7. I PrM H/B X C Y CrM S THE BASIC MODEL No Treasury or Foreign Sector The FED ΔMS Cash ΔMD

8. THE CLOSED MODEL – an important conclusion, Part I E I PrM H/B X C Y TRSY T G FxMCrM FS K BB/Def If we start with a given amount of income (Y), we can picture that money flowing through the economy to where it ends up as spending (X). The rule for this model is: “All the money going into any box will equal the money going out of that box.” Question: “Is it possible that X is ever different from Y?” Answer: “X must always be the same as Y in the CLOSED MODEL” This should sound curious. We have a model that says that total spending (that is, GDP) never changes, when it obviously does in fact change. The model is, nevertheless surprisingly useful particularly as the LONG RUN MODEL.

9. THE CLOSED MODEL – an important conclusion, Part I E I PrM H/B X C Y TRSY T G FxMCrM FS K BB/Def “X must always be the same as Y in the CLOSED MODEL” This is so because the money that leaves Households and Businesses as Income must all go “somewhere.” That money must eventually wind up being spent, since there is nowhere else for it to go.

10. THE CLOSED MODEL – an important conclusion, Part II E I PrM H/B X C Y TRSY T G FxMCrM FS K BB/Def When we add either of two items to the diagram we get a new conclusion. FED ΔMS Cash ΔMD With either ΔMD or ΔMS in the model it is now possible for X and Y to be different BIG CONCLUSION: In order for GDP (spending) to rise or fall there must be a change in either the money supply or money demand. This is because money going to and from Cash or the Fed is going and coming from “nowhere.” The money more or less appears and disappears from the economy.

11. PrM H/B X Cd Y The OPEN Model – the Short Run picture Once we see that X and Y can be different we can build a simpler model. This is particularly useful for the Keynesian, short-run view of the economy. We will divide the economic flows into three parts. 1. Domestic Consumption: this is the part of income that immediately becomes spending. 2. Leakages: these are the parts of income that are not immediately returned to the product market as spending. Leakages = Imports, Saving and Taxes 3. Injections: these are the parts of total spending other than domestic consumption: the parts of spending that do not immediately arise out of current income. Injections = Exports, Investment and Government Purchases

12. The OPEN Model – the Short Run picture In the Open Model the Leakages seem to go “nowhere.” The Injections seem to come from “nowhere.” It can be useful to think of it that way. It is also good to remember that the complete model does contain two “nowheres.” They are … 1. Cash – changes of money demand and 2. the Fed – changes of the money supply

13. The Three Models PrM H/B X Cd Y The OPEN Model the Short Run The MONEY Model the versatile one. This one can do what either of the others can E I PrM H/B X C Y TRSY T G FxMCrM FS KBB FED ΔMS Cash ΔMD E I PrM H/B X C Y TRSY T G FxMCrM FS KBB The CLOSED Model the Long Run Injections = E + I + G Leakages = F + S + T