Chap_34：The Influence of Monetary and Fiscal Policy on Aggregate Demand

1、The Influence of Monetary and Fiscal Policy on Aggregate DemandChapter 34Aggregate DemandnMany factors influence aggregate demand besides monetary and fiscal policy. nIn particular, desired spending by households and business firms determines the overall demand for goods and services.Aggregate Deman

2、dnWhen desired spending changes, aggregate demand shifts, causing short-run fluctuations in output and employment.nMonetary and fiscal policy are sometimes used to offset fset those shifts and stabilize the economy.How Monetary Policy Influences Aggregate DemandnThe aggregate demand curve slopes dow

3、nward for three reasons:pThe wealth effectpThe interest-rate effectpThe exchange-rate effectHow Monetary Policy Influences Aggregate DemandFor the U.S. economy, the most important reason for the downward slope of the aggregate-demand curve is the interest-rate effect.The Theory of Liquidity Preferen

4、cenKeynes developed the theory of liquidity preference in order to explain what factors determine the economys interest rate.nAccording to the theory, the interest rate adjusts to balance the supply and demand for money.The Theory of Liquidity PreferencenMoney quantity demandpLiquidity demandtransac

5、tion demandPrecaution prkn（ prudent) demandpSpeculation demandpMd=L1(Y,P)+L2(r)Pbond=V face/rMoney SupplynThe money supply is controlled by the Fed through:pOpen-market operationspChanging the reserve requirementspChanging the discount dskant rate（rediscount rate）Money SupplynBecause it is fixed by

6、the Fed, the quantity of money supplied does not depend on the interest rate.nThe fixed money supply is represented by a vertical supply curve.Money DemandnMoney demand is determined by several factors.nAccording to the theory of liquidity preference, one of the most important factors is the interes

7、t rate.Money DemandPeople choose to hold money instead sted of other assets that offer higher rates of return because money can be used to buy goods and services.Money DemandnThe opportunity cost of holding money is the interest that could be earned on interest-earning assets.nAn increase in the int

8、erest rate raises the opportunity cost of holding money.nAs a result, the quantity of money demanded is reduced.Equilibrium in the Money MarketnAccording to the theory of liquidity preference:pThe interest rate adjusts to balance the supply and demand for money. pThere is one interest rate, called k

9、:ld the equilibrium interest rate, at which the quantity of money demanded equals the quantity of money supplied.Equilibrium in the Money MarketnAssume the following about the economy:pThe price level is stuck at some level.pFor any given price level, the interest rate adjusts to balance the supply

10、and demand for money.pThe level of output responds to the aggregate demand for goods and services.Equilibrium in the Money Market.Quantity ofMoneyInterestRate0MoneydemandQuantity fixedby the FedMoneysupplyr2M d2r1M d1Equilibrium interest rateSHIBOR:Shanghai Interbank Offered RateFed Funds Rate LIBOR

11、: London Interbank Offered RateThe Downward Slope of the Aggregate Demand CurvenThe price level is one determinant of the quantity of money demanded.pA higher price level increases the quantity of money demanded for any given interest rate.pHigher money demand leads to a higher interest rate.pThe qu

12、antity of goods and services demanded falls.The Downward Slope of the Aggregate Demand CurveThe end result of this analysis is a negative relationship between the price level and the quantity of goods and services demanded.Aggregate demand(b) The Aggregate Demand CurveQuantity of Output0Price Level(

13、a) The Money MarketQuantity of MoneyQuantity fixed by the Fed0r1Money supplyInterest RateMoney demand at price level P1, MD1Y1P1The Money Market and the Slope of the Aggregate Demand Curve.Money demand atprice level P2, MD22. increases the demand for money1. An increase in the price levelP23. which

14、increases the equilibrium equilibrium rater24. which in turn reduces the quantity of goods and services demanded.Y2Changes in the Money SupplynThe Fed can shift the aggregate demand curve when it changes monetary policy. nAn increase in the money supply shifts the money supply curve to the right.nWi

15、thout a change in the money demand curve, the interest rate falls.nFalling interest rates increase the quantity of goods and services demanded.Y2AD23. which increases the quantity of goods and services demanded at a given price level. 1. When the Fed increases the money supplyMS2A Monetary Injection

16、.Y1PQuantity of Output0Price LevelAggregate demand, AD1 (a) The Money MarketQuantity of Money0Money supply, MS1r1Interest Rate(b) The Aggregate-Demand Curver22. the equilibrium interest rate fallsChanges in the Money SupplynWhen the Fed fed increases the money supply, it lowers the interest rate and

17、 increases the quantity of goods and services demanded at any given price level, shifting aggregate-demand to the right.nWhen 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

18、 the left.The Role of Interest-Rate Targets in Fed PolicynMonetary policy can be described either in terms of the money supply or in terms of the interest rate.nChanges 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 su

19、pply.nA target for the federal funds rate affects the money market equilibrium, which influences aggregate demand.How Fiscal Policy Influences Aggregate DemandnFiscal policy refers to the governments choices tisiz regarding (about) the overall level of government purchases or taxes.nFiscal policy in

20、fluences saving, investment, and growth in the long run.nIn the short run, fiscal policy primarily pramrli affects the aggregate demand.Changes in Government PurchasesnWhen policymakers change the money supply or taxes, the effect on aggregate demand is indirect through the spending decisions of fir

21、ms or households.nWhen the government alters lt its own purchases of goods or services, it shifts the aggregate-demand curve directly.Changes in Government PurchasesnThere are two macroeconomic effects from the change in government purchases: pThe multiplier mltpla effectpThe crowding-out effectThe

22、Multiplier EffectnGovernment purchases are said to have a multiplier effect on aggregate demand.nEach dollar spent by the government can raise the aggregate demand for goods and services by more than a dollar.The Multiplier Effect.Aggregate demand, AD1 Quantityof Output0PriceLevelAD2 1. An increase

23、in government purchases of $20 billion initially increases aggregate demand by $20 billion$20 billionAD3 2. but the multiplier effect can amplify the shift in aggregate demand.A Formula for the Spending MultipliernThe formula for the multiplier is:Multiplier = 1/(1 - MPC)nAn important number in this

24、 formula is the marginal propensity to consume (MPC).pIt is the fraction of extra income that a household consumes rather than saves.A Formula for the Spending MultipliernIf the MPC is 3/4, then the multiplier will be:Multiplier = 1/(1 - 3/4) = 4nIn this case, a $20 billion increase in government sp

25、ending generates $80 billion of increased demand for goods and services.The Crowding-Out EffectnFiscal policy may not affect the economy as strongly as predicted by the multiplier.nAn increase in government purchases causes the interest rate to rise.nA higher interest rate reduces investment spendin

26、g.The Crowding-Out EffectnThis reduction in demand that results when a fiscal expansion raises the interest rate is called the crowding-out effect.nThe crowding-out effect tends to dampen the effects of fiscal policy on aggregate demand.AD3 4. which in turn partly offsets the initial increase in agg

27、regate demand.The Crowding-Out Effect.Aggregate demand, AD1(b) The Shift in Aggregate DemandQuantity of Output0Price Level(a) The Money MarketQuantity of MoneyQuantity fixed by the Fed0r1Money demand, MD1 Money supplyInterest Rate1. When an increase in government purchases increases aggregate demand

28、AD2 $20 billion3. which increases the equilibrium interest rater2MD2 2. the increase in spending increases money demandThe Crowding-Out EffectWhen the government increases its purchases by $20 billion, the aggregate demand for goods and services could rise by more or less than $20 billion, depending

29、 on whether the multiplier effect or the crowding-out effect is larger.Changes in TaxesnWhen the government cuts personal income taxes, it increases households take-home pay.pHouseholds save some of this additional income.pHouseholds also spend some of it on consumer goods.pIncreased household spend

30、ing shifts the aggregate-demand curve to the right.Changes in TaxesnThe size of the shift in aggregate demand resulting from a tax change is affected by the multiplier and crowding-out effects.nIt is also determined by the households perceptions about the permanency pmnnsi of the tax change.Using Po

31、licy to Stabilize the EconomyEconomic stabilization has been an explicit goal of U.S. policy since the Employment Act of 1946.The Case for Active Stabilization PolicynThe Employment Act has two implications:pThe government should avoid being the cause of economic fluctuations.pThe government should

32、respond to changes in the private economy in order to stabilize aggregate demand.The Case Against Active Stabilization PolicynSome economists argue that monetary and fiscal policy destabilizes the economy.nMonetary and fiscal policy affect the economy with a substantial lag.nThey suggest the economy

33、 should be left to deal with the short-run fluctuations on its own.Automatic StabilizersnAutomatic stabilizers are changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action.nAutomatic stabilizers include

34、the tax system and some forms of government spending.SummarynKeynes proposed the theory of liquidity preference to explain determinants of the interest rate.nAccording to this theory, the interest rate adjusts to balance the supply and demand for money.SummarynAn increase in the price level raises m

35、oney demand and increases the interest rate.nA higher interest rate reduces investment and, thereby, the quantity of goods and services demanded.nThe downward-sloping aggregate-demand curve expresses this negative relationship between the price-level and the quantity demanded.SummarynPolicymakers can influence aggregate demand with monetary policy.nAn increase in the money supply will ultimately lead to the aggregate-demand curve shifting to the right.nA decrease in the money supply will ultimately lead to the aggregate-demand curve shifting to the left.Summa