University:
California State University, Northridge
Course:
ECON 500 | Survey of Economics
Academic year:

2024
Views:

97

Pages:

13
Author:

Clark Morrison

Managing Aggregate Demand: Monetary Policy Part 2 Overview • How Monetary Policy Works • Money & the Price Level How Monetary Policy Works • Expansionary monetary policy 1. Open-market purchase of T-Bills 2. Lower discount rate 3. Lower required reserve ratio • Contractionary monetary policy 1. Open-market sale of T-Bills 2. Raise discount rate 3. Raise required reserve ratio • **Fed primarily uses open-market transactions to conduct monetary policy** 57 Figure 4 The effects of monetary policy on interest rates S0 S2 S1 S0 D D Interest Rate Interest Rate E A S0 S1 D Bank Reserves (a) Expansionary Monetary Policy B E S2 S0 D Bank Reserves (b) Contractionary Monetary Policy 58 How Monetary Policy Works • Recall: AD: total exp = C + I + G + (X-IM) • Most sensitive components of AD to monetary policy: – Investments are largely financed through borrowing, so interest rates (r) impact the cost of investments • ↑r → ↓I • ↓r → ↑I – Net exports • ↑r → ↑$ → ↓(X-IM) • ↓r → ↓$ → ↑(X-IM) 59 Figure 5 The effect of interest rates on total expenditure 45° C+I+G+(X-IM) (lower interest rate) Real Expenditure C+I+G+(X-IM) C+I+G+(X-IM) (higher interest rate) Real GDP 60 How Monetary Policy Works • Expansionary monetary policy – Lowers r → Encourages I → higher total spending → shifts expenditure schedule up → multiplier effect on AD → raises GDP Federal Reserve  1 2 3 [ ] [ ] → → → M and r I   Policy   →3 [C + I + G + ( X − IM )] →4 [GDP ] 61 Figure 6 The effect of expansionary monetary policy on total expenditure 45° C+I1+G+(X-IM) Real Expenditure E1 C+I0+G+(X-IM) E0 0 5,500 6,000 6,500 Real GDP 7,000 62 How Monetary Policy Works • Effect of monetary policy on AD – Depends on • Sensitivity of interest rates to open-market operations • Responsiveness of investment spending to the interest rate • Size of basic expenditure multiplier 63 Money & Price Level in Keynesian Model • Expansionary monetary policy – Increases quantity of AD • At any given price level – Causes some inflation • Depends on slope of AS curve Federal Reserve  1 2 3 [ ] [ ] M and r I → → →   Policy   →3 [C + I + G + ( X − IM )] →4 [Y and P ] 64 Figure 7 Inflationary effects of expansionary monetary policy D0 D1 Price Level $500 billion 103 S Expansionary monetary policy causes some inflation. But how much depends on the slope of AS. B E 100 S D0 0 6,000 D1 6,400 Real GDP 65 Money & Price Level in Keynesian Model • Why does AD curve slope downward? – Higher price level • Reduces purchasing power of money fixed assets & thereby lowers C • Depress X & Stimulate IM • Increases the quantity of bank deposits demanded – D for bank reserves shifts outward → increases federal funds rate → higher interest rate → discourages I → lowers aggregate quantity demanded 66 Figure 8 The effect of a higher price level on the market for bank reserves D1 E1 Interest Rate D0 At higher P levels, the quantity of bank reserves demanded is greater. Thus, higher prices lead to higher interest rates. S Effect of a higher P E0 S D0 D1 Bank Reserves 67