chapter 21 the influence of monetary fiscal policy on aggregate demand
what happens if the Fed decreases the discount rate?
1. encourages more bank borrowing 2. increase bank reserves 3. increase money supply
what happens when there is an increase in money supply? (think of the two graphs)
1. interest rate falls 2. cost of borrowing for investment reduces 3. the quantity of goods and services demanded at each price level increases 4. aggregate demand shifts to the right
multiplier effect equation
1/(1-MPC)
The long-run effect of an increase in the money supply is to A. increase the price level. B. decrease the price level. C. increase the interest rate. D. decrease the interest rate.
A. increase the price level.
In the market for real output, the initial effect of an increase in the money supply is to A. shift aggregate demand to the right. B. shift aggregate demand to the left. C. shift aggregate supply to the right. D. shift aggregate supply to the left.
A. shift aggregate demand to the right.
When the supply and demand for money are expressed in a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis, an increase in the price level A. shifts money demand to the right and increases the interest rate. B. shifts money demand to the left and increases the interest rate. C. shifts money demand to the right and decreases the interest rate. D. shifts money demand to the left and decreases the interest rate. E. does none of the above.
A. shifts money demand to the right and increases the interest rate.
When an increase in government purchases increases the income of some people, and those people spend some of that increase in income on additional consumer goods, we have seen a demonstration of A. the multiplier effect. B. the investment accelerator. C. the crowding-out effect. D. supply-side economics. E. none of the above.
A. the multiplier effect.
Why does an increase in the price level reduce the quantity demanded of real output? (Use the interest-rate effect to explain the slope of the aggregate-demand curve.)
An increase in the price level shifts money demand to the right, increases the interest rate, and decreases investment.
what specifically does the Fed target? like not interest rate but something more specific
federal funds rates
in what situation would expansionary monetary policy might fail to stimulate the economy?
if the interest rate has reach its zero lower bound
why is the interest rate determined by both the nominal and real interest rate?
in the short run, expected inflation is changing so changes in the nominal rate equal changes in the real rate
changes in monetary policy aimed at expanding aggregate demand...
increase money supply or lower interest rate
does an increase in MPC increase or decrease the multiplier?
increase the multiplier
what is the most important reason for the downward sloping demand curve for the US?
interest-rate effect
in the short run, the price level is or isn't sticky?
is sticky
a tax increase depresses consumer spending and thus shift the AD to the __
left
what is the economy's most liquid asset?
money
why do people have a demand for money?
money is a medium of exchange so people can use it to buy things
Fed can implement monetary policy by targeting what two things?
money supply or interest rates
can the price level adjust in the short run?
no
the interest rate is the ____ _____ for holding money
opportunity cost
what happens when the interest rate is high?
people hold more wealth in interest-bearing bonds and economize on their money holdings
investment accelerator
positive feedback from demand to investment
with a fixed money supply, a larger money demand raises or lowers the interest rate?
raises
the interest rate is determined by both the ___ and ___ interest rate
real and nominal
a higher interest rate reduces or increases investment expenditure?
reduces
if the government buys government bonds, does the money supply shift to the right or left?
right
government spending automatically rises or falls during a recession? why?
rises. b/c unemployment benefits and welfare payments rise
liquidity trap
a situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound
what would eliminate automatic stabilizers?
a strict balanced budget rule
is the quantity of money reduced or increased when the interest rate is high?
decreased
changes in monetary policy aimed at contracting aggregate demand...
decreasing money supply or raise interest rate
Why does the aggregate demand curve slope downward?
due to the wealth effect, interest-rate effect, and exchange-rate effect
in the long run, output is fixed by what?
factor supplies and technology
what two spending systems increase AD during a recession?
tax and government spendings systems
multiplier effect
the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending
liquidity
the ease with which an asset can be converted into a medium of exchange
marginal propensity to consume
the fraction of extra income that a household consumes rather than saves
why would a strict balanced budget rule eliminate automatic stabilizers?
the gov would have to raise taxes or lower expenditures during a recession
what does fiscal policy refer to?
the government's choices of the levels of government purchases and taxes
what is the federal funds rate?
the interest rate banks charge each other for short-term loans
what is the theory of liquidity preference?
the interest rate is determined by the supply and demand for money
why does the Fed usually target the interest rate?
the money supply is hard to measure and money demand fluctuates, causing fluctuations in interest rates, aggregate demand, and output for a given money supply
crowding out effect
the offset in AD that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending
what does the aggregate-demand curve show?
the quantity of all goods and services demanded in the economy at any given price level
in the long run, the interest rate adjusts to balance what?
the supply and demand for loanable funds
in the long run, the interest rate is determined by what?
the supply and demand for loanable funds
for any given price level in the short run, the interest rates adjusts to balance what?
the supply and demand for money
in the long run, the price level adjusts to balance what?
the supply and demand for money
in the short run, the interest rate is determined by what?
the supply and demand for money
what does the money supply curve look like?
vertical line
Which of the following best describes how an increase in the money supply shifts aggregate demand? A. The money supply shifts right, the interest rate rises, investment decreases, and aggregate demand shifts left. B. The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right. C. The money supply shifts right, prices rise, spending falls, and aggregate demand shifts left. D. The money supply shifts right, prices fall, spending increases, and aggregate demand shifts right.
B. The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right.
When an increase in government purchases causes firms to purchase additional plant and equipment, we have seen a demonstration of A. the multiplier effect. B. the investment accelerator. C. the crowding-out effect. D. supply-side economics. E. none of the above.
B. the investment accelerator.
Keynes's liquidity preference theory of the interest rate suggests that the interest rate is determined by A. the supply and demand for loanable funds. B. the supply and demand for money. C. the supply and demand for labor. D. aggregate supply and aggregate demand.
B. the supply and demand for money.
Why is the money supply curve vertical when it is drawn on a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis?
Because the quantity of money is fixed at whatever value the Fed chooses and this quantity is not dependent on the interest rate.
The initial impact of an increase in government spending is to shift A. aggregate supply to the right. B. aggregate supply to the left. C. aggregate demand to the right. D. aggregate demand to the left.
C. aggregate demand to the right.
When money demand is expressed in a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis, an increase in the interest rate A. increases the quantity demanded of money. B. increases the demand for money. C. decreases the quantity demanded of money. D. decreases the demand for money. E. does none of the above.
C. decreases the quantity demanded of money.
Which of the following is an automatic stabilizer? A. military spending B. spending on public schools C. unemployment benefits D. spending on the space shuttle E. All of the above are automatic stabilizers.
C. unemployment benefits
The initial effect of an increase in the money supply is to A. increase the price level. B. decrease the price level. C. increase the interest rate. D. decrease the interest rate.
D. decrease the interest rate.
For the United States, the most important source of the downward slope of the aggregate-demand curve is A. the exchange-rate effect. B. the wealth effect. C. the fiscal effect. D. the interest-rate effect. E. none of the above.
D. the interest-rate effect.
Explain how an increase in the money supply shifts the aggregate-demand curve.
The money supply shifts right, the interest rate decreases, investment increases at each price level, which is a rightward shift in the aggregate-demand curve.
who determines the money supply?
Federal Reserve
Explain why taxes and government spending may act as automatic stabilizers. What would a strict balanced-budget rule cause policymakers to do during a recession? Would this make the recession more or less severe?
Income tax collections fall during a recession, and government spending on welfare and unemployment benefits rises. It would cause the government to raise other taxes and lower other spending. More severe.
How does a cut in taxes affect aggregate supply?
It causes an increase in aggregate supply by increasing the incentive to work.
Which is likely to have a greater impact on aggregate demand: a temporary reduction in taxes or a permanent reduction in taxes? Why?
Permanent because it improves the financial condition of the household more, and thus, they spend more.
Why does the money demand curve slope negatively when it is drawn on a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis?
The interest rate is the opportunity cost of money since money earns no rate of return. Thus, an increase in the interest rate causes people to economize on cash balances and hold more wealth in interest-bearing bonds.
fiscal policy primarily impacts what in the short run?
aggregate demand
shocks to consumption, investment, and net exports may have a multiplier effect on what?
aggregate demand
the interest rate influences what in the short run? (two things)
aggregate demand and thus output
automatic stabilizers
changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action
