The Demand for Money, Case & Fair chapter slides
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Transcript The Demand for Money, Case & Fair chapter slides
Chapter Twenty Eight
Money, the Interest Rate,
and Output: Analysis
and Policy
Links Between the Goods
Market and the Money Market
Income, which is determined in the
goods market, has considerable
influence on the demand for money in
the money market.
The interest rate, which is determined
in the money market, has significant
effects on planned investment in the
goods market.
Planned Investment Schedule
Interest
Rate
15%
10%
5%
I1
I0
I2
Planned
Investment
The Effects of a Change in the
Interest Rate
A high interest rate (r) discourages
planned investment (I)
Planned investment is part of planned
aggregate expenditure (AE)
When the interest rate rises, planned AE
at every level of income falls
The decrease in planned AE lowers
equilibrium output (Y) by a multiple of the
initial increase in planned I.
The Effect of an Interest Rate Increase on
Planned AE
C+I0+G
(r=3%)
Aggregate
Planned
Expenditures
C+I1+G
(r=6%)
45o
Y1
Y0
Aggregate
Output
Equilibrium in the Money Market
Interest
Rate
MS
Excess supply of
money
Excess demand
for money
9
6
3
Md
M d1
Money, M
The effect of an increase in income
(Y) on the interest rate (r) ...
Interest
Rate
9
6
MS
Excess demand
for money
M1d (Y=Y1)
M0d (Y=Y0)
Money, M
Summary
Md
Y
r
I
AE
Md
Y
r
r
I
Y
r
AE
Y
Suppose Expansionary Fiscal Policy...
Fiscal policy which is aimed at
increasing the level of equilibrium
output
Increase in government expenditures
Decrease in taxes
Aggregate
Planned
Expenditures
C+I0+G0
(r=r0)
Y0
Aggregate Output
Aggregate
Planned
Expenditures
Expansionary Fiscal Policy
G1 > G0
C+ I0+G1
(r=r0)
C+ I0+G0
(r=r0)
Y0
Y1
Aggregate
Output
Aggregate
Planned
Expenditures
Increase in r will cause decrease in I
I 1 < I0
C+ I +G
0
(r=r0)
1
C+ I1+G0
(r=r1)
C+ I0+G0
(r=r0)
Y0
Y1
Aggregate
Output
What happened?
Increase G implies increase Y
Increase Y implies increase Md
Increase Md implies increase r
Increase r implies decrease I
Decrease I implies decrease AE
Crowding Out
Crowding Out
Increase in G leads to
decrease in I
Y increases less than if r did
not increase
Effects of an Expansionary Fiscal Policy:
G
Y
r
Md
I
(but Y increases less than if r did not increase)
Effects of an Expansionary Monetary Policy:
MS
r
I
Y
d
M
(but r decreases less than if Md did not increase)
Fed Accommodation of an
Expansionary Fiscal Policy
Interest
Rate
M0 S
M1 S
r1
r0
M1d
M0d
Money, M
Effects of a Contractionary Fiscal Policy:
G
Y
r
Md
I
(but Y decreases less than if r did not decrease)
Effects of a Contractionary Monetary Policy:
MS
r
I
Y
d
M
(but r increases less than if Md did not decrease)
Policy Mix
Policy mix refers to the combination
of monetary and fiscal policies in use
at a given time.
Determinants of Planned
Investment
The interest rate
Expectations of future sales
Capital utilization rates
Relative capital and labor costs
Review Terms & Concepts
Contractionary fiscal
Expansionary
policy
Contractionary
monetary policy
Crowding-out effect
Expansionary fiscal
policy
monetary policy
Goods market
Interest sensitivity of
planned investment
Money market
Policy mix