Chapter 14The AD-AS Model and Monetary Policy.ppt

? 2006 McGraw-Hill Ryerson Limited. All rights reserved. Chapter 14:The AD-AS Model and Monetary Policy Prepared by: Kevin Richter, Douglas College Charlene Richter, British Columbia Institute of Technology Introduction Monetary policy is one of the two main traditional macroeconomic tools to control the aggregate economy. While fiscal policy is controlled by the government directly, monetary policy is controlled by the central bank in Canada. Introduction Monetary policy influences the economy through changes in the money supply and availability of credit. Effect of Monetary Policy on the Macro Policy Model Expansionary monetary policy shifts the AD curve to the right. Contractionary monetary policy shifts the AD curve to the left. Effect of Monetary Policy on the AD/AS Model The effect of monetary policy on equilibrium income and the price level depends on whether inflationary pressures are set in motion. That in turn depends on how close the economy is to its potential income. Effect of Monetary Policy on the AD/AS Model The supply conditions of the economy are central to the effect one believes monetary policy will have on the economy. Effect of Monetary Policy on the Macro Policy Model Expansionary monetary policy increases nominal income. Its effect on real income depends on how the price level responds. % ?Real Income = % ?Nominal Income – % ?Price Level Effect of Monetary Policy on the AS/AD Model In Keynesian range, real income will rise with expansionary monetary policy and decline with contractionary monetary policy. The price level is unaffected. Monetary Policy When Prices are Fixed Monetary Policy in Intermediate Range In the intermediate range, both real income and price level change. Expansionary Monetary Policy in the Intermediate Range Expansionary Monetary Policy in the Classical Range Duties and Structure of the Bank of Canada A central bank conducts monetary policy and acts as financial adviser to the government. Central bank – a