2010 premium ppt macroprinc-ch34-

1、34C H A P T E RTheInfluence of Monetaryand Fiscal Policy on Aggregate DemandEcP RoI N nC I PoL E mSO FicsN. Gregory MankiwPremium PowerPoint Slides by Ron Cronovich 2010 South-Western, a part of Cengage Learning, all rights reserved2010updateIn this chapter,look for the answers to these questions:Ho

2、w does the interest-rate effect help explain the slope of the aggregate-demand curve?How can the central bank use monetary policy to shift the AD curve?In what two ways does fiscal policy affect aggregate demand?What are the arguments for and against using policy to try to stabilize the economy?1Int

3、roductionEarlier chapters covered: the long-run effects of fiscal policyon interest rates, investment, economic growth the long-run effects of monetary policy on the price level and inflation rateThis chapter focuses on the short-run effects of fiscal and monetary policy,which work through aggregate

4、 demand.2THE INFLUENCE OF MONETARY AND FISCAL POLICYAggregate DemandRecall, the AD curve slopes downward for three reasons: The wealth effect The exchange-rate effectNext:A supply-demand model that helps explain the interest-rate effect and how monetary policyaffects aggregate demand.3THE INFLUENCE

5、OF MONETARY AND FISCAL POLICYThe interest-rate effectthe most important of these effects for the U.S. economyThe Theory of Liquidity PreferenceA simple theory of the interest rate (denoted r)r adjusts to balance supply and demand for moneyMoney supply:assume fixed by central bank,does not depend on

6、interest rate4THE INFLUENCE OF MONETARY AND FISCAL POLICYThe Theory of Liquidity PreferenceMoney demand reflects how much wealth people want to hold in liquid form.For simplicity, suppose household wealth includes only two assets: Money liquid but pays no interest Bonds pay interest but not as liqui

7、dA households “money demand” reflects itspreference for liquidity.The variables that influence money demand:Y, r, and P.5THE INFLUENCE OF MONETARY AND FISCAL POLICYMoney DemandSuppose real income (Y) rises.Other things equal,what happens to money demand?If Y rises: Households want to buy more g&s, s

8、o they need more money. To get this money, they attempt to sell some of their bonds.I.e., an increase in Y causesan increase in money demand, other things equal.6THE INFLUENCE OF MONETARY AND FISCAL POLICYL E A R N I N G1A C T I V E The determinants of money demandA. Suppose r rises, but Y and P are

9、 unchanged. What happens to money demand?B. Suppose P rises, but Y and r are unchanged. What happens to money demand?7L E A R N I N G1A C T I V E AnswersA. Suppose r rises, but Y and P are unchanged. What happens to money demand?r is the opportunity cost of holding money.An increase in r reduces mon

10、ey demand: households attempt to buy bonds to take advantage of the higher interest rate.Hence, an increase in r causes a decrease in money demand, other things equal.8L E A R N I N G1A C T I V E AnswersB. Suppose P rises, but Y and r are unchanged. What happens to money demand?If Y is unchanged, pe

11、ople will want to buy the same amount of g&s.Since P is higher, they will need more money to do so.Hence, an increase in P causes an increase in money demand, other things equal.9How rIs DeterminedInterestrateMS curve is vertical: Changes in r do not affect MS, which is fixed by the Fed.MD curve is

12、downward sloping: A fall in r increases money demand.r11M10THE INFLUENCE OF MONETARY AND FISCAL POLICYQuantity fixed by the FedEqm interest rateMSMDHow the Interest-Rate Effect Works A fall in P reduces money demand, which lowers r.InterestratePr1P1r2P21MY1Y2Y A fall in r increases I and the quantit

13、y of g&s demanded.11THE INFLUENCE OF MONETARY AND FISCAL POLICYADMSMD MD2Monetary Policy and Aggregate DemandTo achieve macroeconomic goals, the Fed can use monetary policy to shift the AD curve.The Feds policy instrument is MS.The news often reports that the Fed targets the interest rate. More prec

14、isely, the federal funds rate which banks charge each other on short-term loansTo change the interest rate and shift the AD curve, the Fed conducts open market operationsto change MS.12THE INFLUENCE OF MONETARY AND FISCAL POLICYThe Effects of Reducing the Money Supply The Fed can raise r by reducing

15、 the money supply.InterestratePr2P1r11MY2Y1Y An increase in r reduces the quantity of g&s demanded.13THE INFLUENCE OF MONETARY AND FISCAL POLICYAD AD2MS2MS1MDL E A R N I N G2A C T I V E Monetary policyFor each of the events below,- determine the short-run effects on output- determine how the Fed sho

16、uld adjust the money supply and interest rates to stabilize outputA. Congress tries to balance the budget by cutting govt spending.B. A stock market boom increases household wealth.C. War breaks out in the Middle East, causing oil prices to soar.14L E A R N I N G2A C T I V E AnswersA. Congress tries

17、 to balance the budget by cutting govt spending.This event would reduce agg demand and output.To offset this event, the Fed should increaseMS and reduce rto increase agg demand.15L E A R N I N G2A C T I V E AnswersB. A stock market boom increases household wealth.This event would increase agg demand

18、, raising output above its natural rate.To offset this event, the Fed should reduce MSand increase rto reduce agg demand.16L E A R N I N G2A C T I V E AnswersC. War breaks out in the Middle East, causing oil prices to soar.This event would reduce agg supply, causing output to fall.To offset this eve

19、nt, the Fed should increaseMS and reduce rto increase agg demand.17Fiscal Policy and Aggregate DemandFiscal policy:the setting of the level of govtspending and taxation by govt policymakersExpansionary fiscal policy an increase in G and/or decrease in T shifts AD rightContractionary fiscal policy a

20、decrease in G and/or increase in T shifts AD leftFiscal policy has two effects on AD.18THE INFLUENCE OF MONETARY AND FISCAL POLICY1.The Multiplier EffectIf the govt buys $20b of planes from Boeing, Boeings revenue increases by $20b.This is distributed to Boeings workers (as wages) and owners (as pro

21、fits or stock dividends).These people are also consumers and will spend a portion of the extra income.This extra consumption causes further increases in aggregate demand.Multiplier effect:the additional shifts in ADthat result when fiscal policy increases incomeand thereby increases consumer spendin

22、g19THE INFLUENCE OF MONETARY AND FISCAL POLICY1.The Multiplier EffectA $20b increase in Ginitially shifts ADto the right by $20b.The increase in Y causes C to rise, which shifts AD further to the right.PP1Y2Y1Y3Y20THE INFLUENCE OF MONETARY AND FISCAL POLICYAD2AD3AD1$20 billionMarginal Propensity to

23、ConsumeHow big is the multiplier effect?It depends on how much consumers respond to increases in income.Marginal propensity to consume (MPC): the fraction of extra income that households consume rather than saveE.g., if MPC = 0.8 and income rises $100,C rises $80.21THE INFLUENCE OF MONETARY AND FISC

24、AL POLICYA Formula for the MultiplierNotation:DG is the change in G,DY and DC are the ultimate changes in Y and CY = C + I + G + NXDY = DC + DGDY = MPC DY + DGidentityI and NX do not change because DC = MPC DY solved for DYDY =DG The multiplier22THE INFLUENCE OF MONETARY AND FISCAL POLICY 11 MPCA Fo

25、rmula for the MultiplierThe size of the multiplier depends on MPC.E.g.,if MPC = 0.5if MPC = 0.75 if MPC = 0.9multiplier = 2multiplier = 4multiplier = 10A bigger MPC means changes in Y cause bigger changes in C, which in turn causemore changes in Y.DY =DG The multiplier23THE INFLUENCE OF MONETARY AND

26、 FISCAL POLICY 11 MPCOther Applications of the Multiplier EffectThe multiplier effect:Each $1 increase in G can generate more than a $1 increase in agg demand.Also true for the other components of GDP.Example:Suppose a recession overseasreduces demand for U.S. net exports by $10b. Initially, agg dem

27、and falls by $10b.The fall in Y causes C to fall, which furtherreduces agg demand and income.24THE INFLUENCE OF MONETARY AND FISCAL POLICY2.The Crowding-Out EffectFiscal policy has another effect on ADthat works in the opposite direction.A fiscal expansion raises r, which reduces investment,which re

28、duces the net increase in agg demand.So, the size of the AD shift may be smaller than the initial fiscal expansion.This is called the crowding-out effect.25THE INFLUENCE OF MONETARY AND FISCAL POLICYHow the Crowding-Out Effect Works A $20b increase in G initially shifts AD right by $20bInterestrateP

29、r2P1r12MY3Y1Y2Y But higher Y increases MD and r, which reduces AD.26THE INFLUENCE OF MONETARY AND FISCAL POLICYAD2AD1 AD3$20 billionMSMD MD1Changes in TaxesA tax cut increases households take-home pay.Households respond by spending a portion of this extra income, shifting AD to the right.The size of

30、 the shift is affected by the multiplier and crowding-out effects.Another factor:whether households perceive thetax cut to be temporary or permanent. A permanent tax cut causes a bigger increase inC and a bigger shift in the AD curve than a temporary tax cut.27THE INFLUENCE OF MONETARY AND FISCAL PO

31、LICYL E A R N I N G3A C T I V E ExerciseThe economy is in recession.Shifting the AD curve rightward by $200b would end the recession.A. If MPC = .8 and there is no crowding out, how much should Congress increase G to end the recession?B. If there is crowding out, will Congress need to increase G mor

32、e or less than this amount?28L E A R N I N G3A C T I V E AnswersThe economy is in recession.Shifting the AD curve rightward by $200b would end the recession.A.If MPC = .8 and there is no crowding out, how much should Congress increase G to end the recession?Multiplier = 1/(1 .8) = 5 Increase G by $4

33、0bto shift agg demand by5 x $40b=$200b.29L E A R N I N G3A C T I V E AnswersThe economy is in recession.Shifting the AD curve rightward by $200b would end the recession.B.If there is crowding out, will Congress need to increase G more or less than this amount?Crowding out reduces the impact of G on

34、AD.To offset this, Congress should increase G by a larger amount.30Fiscal Policy and Aggregate SupplyMost economists believe the short-run effects of fiscal policy mainly work through agg demand.But fiscal policy might also affect agg supply. Recall one of the Ten Principles from Chap 1:People respo

35、nd to incentives.A cut in the tax rate gives workers incentive to work more, so it might increase the quantity of g&s supplied and shift AS to the right.People who believe this effect is large are called “Supply-siders.”31THE INFLUENCE OF MONETARY AND FISCAL POLICYFiscal Policy and Aggregate SupplyG

36、ovt purchases might affect agg supply. Example: Govt increases spending on roads. Better roads may increase business productivity, which increases the quantity of g&s supplied, shifts AS to the right.This effect is probably more relevant in the longrun:it takes time to build the new roads and putthe

37、m into use.32THE INFLUENCE OF MONETARY AND FISCAL POLICYUsing Policy to Stabilize the EconomySince the Employment Act of 1946, economic stabilization has been a goal of U.S. policy.Economists debate how active a role the govt should take to stabilize the economy.33THE INFLUENCE OF MONETARY AND FISCA

38、L POLICYThe Case for Active Stabilization PolicyKeynes:“Animal spirits” cause waves ofpessimism and optimism among households and firms, leading to shifts in aggregate demand and fluctuations in output and employment.Also, other factors cause fluctuations, e.g., booms and recessions abroad stock mar

39、ket booms and crashesIf policymakers do nothing, these fluctuations are destabilizing to businesses, workers, consumers.34THE INFLUENCE OF MONETARY AND FISCAL POLICYThe Case for Active Stabilization PolicyProponents of active stabilization policy believe the govt should use policyto reduce these flu

40、ctuations: When GDP falls below its natural rate,use expansionary monetary or fiscal policy to prevent or reduce a recession. When GDP rises above its natural rate,use contractionary policy to prevent or reducean inflationary boom.35THE INFLUENCE OF MONETARY AND FISCAL POLICYKeynesians in the White

41、House1961:John F Kennedy pushed for a tax cut to stimulate agg demand. Several of his economic advisorswere followers of Keynes.2009:Barack Obama pushed for spending increases and tax cuts to increase agg demand in theface of a deep recession.36THE INFLUENCE OF MONETARY AND FISCAL POLICYThe Case Aga

42、inst Active Stabilization PolicyMonetary policy affects economy with a long lag: Firms make investment plans in advance, so I takes time to respond to changes in r. Most economists believe it takes at least6 months for mon policy to affect output and employment.Fiscal policy also works with a long l

43、ag: Changes in G and T require Acts of Congress. The legislative process can take months or years.37THE INFLUENCE OF MONETARY AND FISCAL POLICYThe Case Against Active Stabilization PolicyDue to these long lags, critics of active policy argue that such policies may destabilize the economy rather than

44、 help it:By the time the policies affect agg demand, the economys condition may have changed.These critics contend that policymakers should focus on long-run goals like economic growth and low inflation.38THE INFLUENCE OF MONETARY AND FISCAL POLICYAutomatic StabilizersAutomatic stabilizers:changes i

45、n fiscal policy that stimulateagg demand when economy goes into recession, without policymakers having to take any deliberate action39THE INFLUENCE OF MONETARY AND FISCAL POLICYAutomatic Stabilizers:The tax systemExamples In recession, taxes fall automatically, which stimulates agg demand.Govt spend

46、ing In recession, more people apply for public assistance (welfare, unemployment insurance). Govt spending on these programs automatically rises, which stimulates agg demand.40THE INFLUENCE OF MONETARY AND FISCAL POLICYCONCLUSIONPolicymakers need to consider all the effects oftheir actions.For example, When Congress cuts taxes, it should consider the short-run effects on agg demand and employment, and the long-run effectson saving and growth. When the Fed reduces the rate of money g