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Trang 1The Influence of Monetary and Fiscal Policy on Aggregate Demand
How Monetary Policy influences Aggregate Demand
The aggregate-demand curve is
downward sloping for 3 reasons
Wealth effect Interest Rate effect Exchange Rate effect
Liquidity preference:
- Interest Rate
- Money Supply
- Money Demand
Money Supply
Because the Fed can control the size of the money supply directly, the quantity of money supplied does not depend on any other economic variables, including the interest rate
Thus, the supply of money is represented by a vertical supply curve
Money Demand
The Interest Rate
rises, the quantity
of money
demanded will fall.
=> the demand for money will be downward sloping
Equilibrium in the Money Market
The Interest Rate adjusts to bring money supply and money demand into balance
If the interest rate > the equilibrium
interest rate, the quantity of money that
people want to hold < the quantity that the Fed
has supplied => This surplus of money put
downward pressure on the Interest Rates.
Changes in Money Supply
Monetary injection by the Fed increases the money supply, leading to a lower interest rate, and a larger quantity of goods and services demanded.
The role of Interest rate Targets in Fed Policy
Federal Funds Rate: short-term
CHANGES in
Governement Purchases
2 effects cause size of the shift in AD curve
=> I decrease => AD decrease
The additional shifts in aggregate demand that
result when expansionary fiscal policy increases
income and thereby
increases consumer spending
The offset in aggregate demand that results
when expansionary fiscal policy raises the
interest rate and thereby reduces investment spending.
Taxes
Government cuts Personal Income Tax
=> Changes in taxes affect a
household’s take-home pay
Automatic stabilizers:
changes in fiscal policy that stimulate aggregate demand when the economy goes into
a recession but that occur without policymakers having
to take any deliberate action