Microeconomics Chapter15.pptxVIP

N. Gregory Mankiw In this chapter, look for the answers to these questions: How 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? Introduction Earlier chapters covered: the long-run effects of fiscal policy on interest rates, investment, economic growth the long-run effects of monetary policy on the price level and inflation rate This chapter focuses on the short-run effects of fiscal and monetary policy, which work through aggregate demand. 0 Aggregate Demand Recall, the AD curve slopes downward for three reasons: The wealth effect The interest-rate effect The exchange-rate effect Next: A supply-demand model that helps explain the interest-rate effect and how monetary policy affects aggregate demand. 0 The Theory of Liquidity Preference A simple theory of the interest rate (denoted r) r adjusts to balance supply and demand for money Money supply: assume fixed by central bank, does not depend on interest rate 0 The Theory of Liquidity Preference Money 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 liquid A household’s “money demand” reflects its preference for liquidity. The variables that influence money demand: Y, r, and P. 0 Money Demand Suppose real income (Y) rises. Other things equal, what happens to money demand? If Y rises: Households want to buy more gs, so they need more money. To get this money, they attempt to sell some of their bonds. I.e., an increase in Y causes an increase in money demand, other things equal. 0 ACTIVE LEARNING 1 The determinants of money demand A. Suppose r rises, but Y and P are unchanged. What hap