Case econ08 ppt_25

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Case econ08 ppt_25

  1. 1. PART VI MACROECONOMIC ANALYSIS Chapter 25 Money, the Interest Rate, and Output: Analysis and Policy Prepared by: Fernando & Yvonn Quijano © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
  2. 2. CHAPTER 25: Money, the Interest Rate, and Output: PART IV MACROECONOMIC ANALYSIS Money, the Interest Rate, and Output: Analysis and Policy 25 Chapter Outline Analysis and Policy The Links Between the Goods Market and the Money Market Investment, the Interest Rate, and the Goods Market Money Demand, Aggregate Output (Income), and the Money Market Combining the Goods Market and the Money Market Expansionary Policy Effects Contractionary Policy Effects The Macroeconomic Policy Mix Other Determinants of Planned Investment Looking Ahead: The Price Level Appendix: The IS-LM Diagram © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 27
  3. 3. MONEY, THE INTEREST RATE, AND OUTPUT: ANALYSIS AND POLICYCHAPTER 25: Money, the Interest Rate, and Output: goods market The market in which goods and services are exchanged and in which the equilibrium level of Analysis and Policy aggregate output is determined. money market The market in which financial instruments are exchanged and in which the equilibrium level of the interest rate is determined. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 3 of 27
  4. 4. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: There are two key links between the goods market and the money market: Analysis and Policy ■ Link 1: Income and the Demand for Money Income, which is determined in the goods market, has considerable influence on the demand for money in the money market. ■ Link 2: Planned Investment Spending and the Interest Rate The interest rate, which is determined in the money market, has significant effects on planned investment in the goods market. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 4 of 27
  5. 5. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Analysis and Policy FIGURE 12.1 Links Between the Goods Market and the Money Market © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 5 of 27
  6. 6. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: INVESTMENT, THE INTEREST RATE, AND THE GOODS MARKET Analysis and Policy When the interest rate falls, planned investment rises. When the interest rate rises, planned investment falls. FIGURE 12.2 Planned Investment Schedule © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 6 of 27
  7. 7. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Analysis and Policy FIGURE 12.3 The Effect of an Interest Rate Increase on Planned Aggregate Expenditure © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 7 of 27
  8. 8. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: The effects of a change in the interest rate include: ■ High interest rate (r) discourages planned investment (I). ■ Planned investment is a part of planned aggregate expenditure (AE). ■ Thus, when the interest rate rises, planned aggregate expenditure (AE) at every level of income falls. Analysis and Policy ■ Finally, a decrease in planned aggregate expenditure lowers equilibrium output (income) (Y) by a multiple of the initial decrease in planned investment. Using a convenient shorthand: r ↑→ I ↓→ AE ↓→ Y ↓ r ↓→ I ↑→ AE ↑→ Y ↑ © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 8 of 27
  9. 9. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: MONEY DEMAND, AGGREGATE OUTPUT (INCOME), AND THE MONEY MARKET Analysis and Policy FIGURE 12.4 Equilibrium in the Money Market © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 9 of 27
  10. 10. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Analysis and Policy FIGURE 12.5 The Effect of an Increase in Income (Y) on the Interest Rate (r) © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 10 of 27
  11. 11. THE LINKS BETWEEN THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: The equilibrium level of the interest rate is not determined exclusively in the money market. Changes in aggregate output (income) (Y), which take place in the goods market, shift the money demand curve and cause changes in the interest rate. With a given quantity of money supplied, higher levels of Y will lead to higher equilibrium levels of r. Lower levels of Y will lead to lower equilibrium Analysis and Policy levels of r, as represented in the following symbols: Y ↑→ M d ↑→ r ↑ Y ↓→ M ↓→ r ↓ d © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 11 of 27
  12. 12. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: EXPANSIONARY POLICY EFFECTS expansionary fiscal policy An increase in government spending or a Analysis and Policy reduction in net taxes aimed at increasing aggregate output (income) (Y). expansionary monetary policy An increase in the money supply aimed at increasing aggregate output (income) (Y). © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 12 of 27
  13. 13. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Expansionary Fiscal Policy: An Increase in Government Purchases (G) or a Decrease in Net Taxes (T) Analysis and Policy crowding-out effect The tendency for increases in government spending to cause reductions in private investment spending. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 13 of 27
  14. 14. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Analysis and Policy FIGURE 12.6 The Crowding-Out Effect © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 14 of 27
  15. 15. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: interest sensitivity or insensitivity of planned investment The responsiveness of planned investment spending to changes in the interest rate. Analysis and Policy Interest sensitivity means that planned investment spending changes a great deal in response to changes in the interest rate; interest insensitivity means little or no change in planned investment as a result of changes in the interest rate. Effects of an expansionary fiscal policy: G ↑→ Y ↑→ M d ↑→ r ↑→ I ↓ Y increases less than if r did not increase © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 15 of 27
  16. 16. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Expansionary Monetary Policy: An Increase in the Money Supply Analysis and Policy Effects of an expansionary monetary policy: M s ↑→ r ↓→ I ↑→ Y ↑→ M d ↑ d r decreases less than if M did not increase © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 16 of 27
  17. 17. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Expansionary Policy in Action: The Recessions of 1974–1975, 1980–1982, 1990–1991, and 2001 Analysis and Policy FIGURE 12.7 Fed Accommodation of an Expansionary Fiscal Policy © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 17 of 27
  18. 18. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: CONTRACTIONARY POLICY EFFECTS Contractionary Fiscal Policy: A Decrease in Government Spending (G) or an Analysis and Policy Increase in Net Taxes (T) contractionary fiscal policy A decrease in government spending or an increase in net taxes aimed at decreasing aggregate output (income) (Y). Effects of a contractionary fiscal policy: G ↓ or T ↑→ Y ↓→ M d ↓→ r ↓→ I ↑ Y decreases less than if r did not decrease © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 18 of 27
  19. 19. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: Contractionary Monetary Policy: A Decrease in the Money Supply Analysis and Policy contractionary monetary policy A decrease in the money supply aimed at decreasing aggregate output (income) (Y). Effects of a contractionary monetary policy: M s ↓→ r ↑→ I ↓→ Y ↓→ M d ↓ d r increases less than if M did not decrease © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 19 of 27
  20. 20. COMBINING THE GOODS MARKET AND THE MONEY MARKETCHAPTER 25: Money, the Interest Rate, and Output: THE MACROECONOMIC POLICY MIX policy mix The combination of monetary and fiscal policies in use at a given time. Analysis and Policy TABLE 12.1 The Effects of the Macroeconomic Policy Mix FISCAL POLICY Expansiona ry Contractio nary (↑ G or ↓ T ) (↓ G or ↑ T ) Expansiona ry Y ↑, r ?, I ?, C ↑ Y ?, r ↓, I ↑, C ? (↑ M s ) Monetary Policy Contractio nary Y ?, r ↑, I ↓, C ? Y ↓, r ?, I ?, C ↓ (↓ M s ) Key : ↑: Variable increases. ↓: Variable decreases. ? : Forces push the variable in different directions . Without additional informatio n, we cannot specify which way the variable moves. © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 20 of 27
  21. 21. OTHER DETERMINANTS OF PLANNED INVESTMENTCHAPTER 25: Money, the Interest Rate, and Output: The determinants of planned investment are ■ The interest rate Analysis and Policy ■ Expectations of future sales ■ Capital utilization rates ■ Relative capital and labor costs © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 21 of 27
  22. 22. REVIEW TERMS AND CONCEPTSCHAPTER 25: Money, the Interest Rate, and Output: contractionary fiscal policy contractionary monetary policy crowding-out effect Analysis and Policy expansionary fiscal policy expansionary monetary policy goods market interest sensitivity or insensitivity of planned investment money market policy mix © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 22 of 27
  23. 23. Appendix ACHAPTER 25: Money, the Interest Rate, and Output: THE IS-LM DIAGRAM THE IS CURVE An IS curve illustrates Analysis and Policy the negative relationship between the equilibrium value of aggregate output (income) (Y) and the interest rate in the goods market. FIGURE 12A.1 The IS Curve © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 23 of 27
  24. 24. Appendix ACHAPTER 25: Money, the Interest Rate, and Output: THE LM CURVE An LM curve illustrates the positive relationship Analysis and Policy between the equilibrium value of the interest rate and aggregate output (income) (Y) in the money market. FIGURE 12A.2 The LM Curve © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 24 of 27
  25. 25. Appendix ACHAPTER 25: Money, the Interest Rate, and Output: THE IS-LM DIAGRAM The IS-LM diagram is a way of depicting Analysis and Policy graphically the determination of aggregate output (income) and the interest rate in the goods and money markets. FIGURE 12A.3 The IS-LM Diagram © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 25 of 27
  26. 26. Appendix ACHAPTER 25: Money, the Interest Rate, and Output: Analysis and Policy FIGURE 12A.4 An Increase in Government Purchases (G) © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 26 of 27
  27. 27. Appendix ACHAPTER 25: Money, the Interest Rate, and Output: Analysis and Policy FIGURE 12A.5 An Increase in the Money Supply (M s) © 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 27 of 27

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