National Income & Business Cycles

Transcription

1 National Income & Business Cycles Ohio Wesleyan Univesity Goan Skosples 9. - and Aggegate Demand Context & Objectives Chapte 11 (10) developed the - model, the basis of the aggegate demand cuve. In Chapte 12 (11), we will use the - model to see how policies and shocks affect income and the inteest ate in the shot un when pices ae fixed deive the aggegate demand cuve We will analyze the shot- and long-un effects of monetay and fiscal policies 0 1 Equilibium in the - Model olicy analysis with the - Model The cuve epesents equilibium in the goods maket. The cuve epesents money maket equilibium. The intesection detemines the unique combination of and that satisfies equilibium in both makets. 2 We can use the - model to analyze the effects of fiscal policy: monetay policy: 1 1 3

2 An incease in govenment puchases Monetay olicy: an incease in M 1. cuve shifts causing output & income to ise. 2. This money demand, causing the inteest ate to 3. which investment, so the final incease in 1. M > 0 shifts the cuve 2. causing the inteest ate to 3. which investment, causing output & income to Result: M and Result: G & 4 5 Inteaction between monetay & fiscal policy Model: Monetay & fiscal policy vaiables (M, G, and T) ae. Real wold: Monetay policymakes may adjust M in esponse to changes in fiscal policy, o vice vesa. Such inteaction may alte the impact of the oiginal policy change. The Fed s esponse to G > 0 Suppose Congess inceases G. ossible Fed esponses: 1. hold M constant 2. hold constant 3. hold constant In each case, the effects of the G ae diffeent 6 7

3 Response 1: Hold M constant Response 2: Hold constant If Congess aises G, the cuve shifts. 1 If Congess aises G, the cuve shifts ight. 1 If Fed holds M constant, then cuve. 1 To keep constant, Fed M to shift cuve. 2 1 Results: 1 Results: Response 3: Hold constant If Congess aises G, the cuve shifts ight. To keep constant, Fed M to shift cuve. Results: Estimates of fiscal policy multiplies fom the DRI macoeconometic model Assumption about monetay policy Fed holds money supply constant Fed holds nominal inteest ate constant Estimated value of /G Estimated value of /T

4 Estimates of fiscal policy multiplies Estimates of fiscal policy multiplies Shocks in the - Model shocks: exogenous changes in the demand fo goods & sevices. stock maket boom o cash change in households wealth change in business o consume confidence o expectations ( animal spiits ) shocks: exogenous changes in the demand fo money. a wave of cedit cad faud demand fo money moe ATMs o the Intenet money demand 14 Execise: Analyze shocks with the - model Use the - model to analyze the effects of A boom in the stock maket makes consumes wealthie. Afte a wave of cedit cad faud, consumes use cash moe fequently in tansactions. Fo each shock, use the - diagam to show the effects of the shock on and. detemine what happens to C, I, and the unemployment ate. 15

5 Execise: A boom in the stock maket makes consumes wealthie Which cuve shifts and why?, because of Effects on: C I 1 1 Execise: Afte a wave of cedit cad faud, consumes use cash moe fequently in tansactions Which cuve shifts and why?, because of Effects on: C I U/L 16 U/L CASE STUD: The U.S. ecession of 2001 Duing 2001, 2.1 million people lost thei jobs, as unemployment ose fom 3.9% to 5.8%. GD gowth slowed to 0.8% (compaed to 3.9% aveage annual gowth duing ). CASE STUD: The U.S. ecession of 2001 Causes: 1) Stock maket decline Index (1942 = 100) Standad & oo s 500 C

6 CASE STUD: The U.S. ecession of 2001 Causes: 2) 9/11 inceased uncetainty fall in consume & business confidence esult: lowe spending, cuve shifted left Causes: 3) Copoate accounting scandals Enon, WoldCom, etc. educed stock pices, discouaged investment CASE STUD: The U.S. ecession of 2001 Fiscal policy esponse: shifted cuve tax cuts in 2001 and 2003 spending inceases - ailine industy bailout - NC econstuction - Afghanistan wa CASE STUD: The U.S. ecession of 2001 Monetay policy esponse: shifted cuve Thee-month T-Bill Rate What is the Fed s policy instument? The news media commonly epot the Fed s policy changes as inteest ate changes, as if the Fed has diect contol ove maket inteest ates. In fact, the Fed tagets the ate the inteest ate banks chage one anothe on ovenight loans. The Fed changes the money supply and shifts the cuve to achieve its taget. Othe shot-tem ates typically move with the fedeal funds ate

7 - and Aggegate Demand Deiving the AD cuve So fa, we ve been using the - model to analyze the shot un, when the pice level is assumed fixed. Howeve, a change in would shift the cuve and theefoe affect. Why? The aggegate demand cuve captues this elationship between and Intuition fo slope of AD cuve: (M/ ) shifts I 1 1 ( 1 ) Definition: Aggegate demand indicates the quantity demanded at a given pice level 1 1 AD Monetay policy and the AD cuve Fiscal policy and the AD cuve The Fed can incease aggegate demand: M shifts 1 1 (M 1 / 1 ) Expansionay fiscal policy (G and/o T ) inceases AD: T C shifts 1 1 I at each value of 1 1 AD 1 of at each value 1 1 AD

8 Aggegate Supply in the Long Run The long-un aggegate supply cuve Recall fom chapte 3: In the long-un, output is detemined by facto supplies and technology is the full-employment o natual level of output, the level of output at which the economy s esouces ae employed. The LRAS cuve is vetical at the fullemployment level of output. Full employment means that unemployment equals its ate. does not depend on the pice level, so the long un aggegate supply (LRAS) cuve is : Aggegate Supply in the Shot Run The shot un aggegate supply cuve In the eal wold, many pices ae in the shot un. If we assume that all pices ae stuck at a pedetemined level in the shot un and that fims ae willing to sell as much as thei customes ae willing to buy at that pice level....then, the shot-un aggegate supply (SRAS) cuve is : The SRAS cuve is hoizontal: The pice level is fixed at a pedetemined level, and fims sell as much as buyes demand

9 - and AD-AS in the shot un & long un The foce that moves the economy fom the shot un to the long un is the gadual adjustment of pices. In the shot-un equilibium, if then ove, the pice level will 0 Fiscal policy: Incease in G 0 LRAS 0 (M 0 / 0 ) G shifts & AD shifts now, 1 0 SRAS shifts 32 o 0 SRAS 0 AD 0 until the new equilibium is eached: 0 & 1 33 Effects of a fiscal policy ove F has eal effects in the SR and in the LR in this model SR:,, LR:,, 34 Fiscal policy in the long un oint: F has eal effects in the SR and in the LR in this model. In this example cowding out occus. The incease in govenment expenditue (G) stimulates in the SR. In the LR, howeve, is fixed. Thus, the incease in the eal inteest ate ( ) causes pivate investment to decease to offset the incease in G. ivate investment is cowded out by govenment spending and emains fixed at 0 = F(K,L). 35

10 Execise: Analyze SR & LR effects of M a. Suppose Fed inceases M. Show the SR effects on you gaphs. b. Show what happens in the tansition fom the SR to the LR. c. How do the new LR equilibium values of the endogenous vaiables compae to thei initial values? Use the gaphs povided on the next slide o Monetay policy: Incease in M 0 LRAS 0 0 (M 0 / 0 ) AD 0 SRAS 1 M shifts & shifts now, 1 0 shifts until the new equilibium is eached: 0 and 1 37 Effects of a monetay policy ove Summay M is effective in the SR but ineffective in the LR in this model 1. - model a theoy of aggegate demand exogenous: M, G, T, exogenous in shot un, in long un endogenous:, endogenous in shot un, in long un cuve: goods maket equilibium cuve: money maket equilibium SR:,, LR:,, 38 39

11 Summay 2. AD cuve shows elation between and the - model s equilibium. negative slope because (M/ ) I expansionay fiscal policy shifts cuve ight, aises income, and shifts AD cuve ight expansionay monetay policy shifts cuve ight, aises income, and shifts AD cuve ight o shocks shift the AD cuve Summay 3. Shot- and long-un effects of F and M Fiscal policy has eal effects in the SR and in the LR in this model (eal inteest ate inceases in the LR govenment spending cowds out pivate investment) Monetay policy is effective in the SR but ineffective in the LR in this model 40 41