The Influence of Monetary and Fiscal Policy on Aggregate Demand

change in fiscal policy that stimulate demand when economy goes into recessions (tax system such as tax cuts; government spending such as income support)

automatic stabilizer

interest rate adjusts to bring money supply and demand into balance

liquidity preference theory

assets liquidated for easier use in economy

money holdings

Fed receive money and bank reserves fall

open-market sales

aggregate demand to the left

A decrease in government spending initially and primarily shifts:

an increase in personal consumption

A reduction in personal income taxes increases Aggregate Demand through

liquidity trap.

A situation in which the Fed's target interest rate has fallen as far as it can fall is sometimes described as a:

classical theory, but not liquidity preference theory

A surplus or shortage in the money market is eliminated by adjustments in the price level according to

the MPC is large and if the tax cut is permanent

A tax cut shifts the aggregate demand curve the farthest if

unemployment benefits

An example of an automatic stabilizer is

increases the multiplier, so that changes in government expenditures have a larger effect on aggregate demand.

An increase in the MPC:

infinity

As the MPC gets close to 1, the value of the multiplier approaches

open-market purchase

Fed spend money that is deposited into bank and raises bank reserves

small part of household wealth, and so the wealth effect is small.

For the U.S. economy, money holdings are a:

decreases and aggregate demand shifts left.

If the Fed conducts open-market sales, the money supply

marginal propensity to consume - fraction of extra income that is consumed rather than saved

MPC

crowding-out effect

reduction in aggregate demand when interest rates increase

multiplier effect

shift in demand when expansionary fiscal policy increases income and consumer spending