CH 11: Monetary Policy & the IS-MP model

When do automatic stabilizers take effect? How large are they? What is the effect in the IS-MP model?

Automatic stabilisers work in response to an increase in uncertainty that leads to reduced investment

How does the Fed try to control the long-term real interest rate?

Control the federal funds rate, it's a short-term nominal interest rate

What is the effect of a decrease in personal income and/or payroll taxes? What is the multiplier? How does it compare to the multiplier for government spending?

Expansionary fiscal policy: Taxes to oto go down, increase in disposable income, C will increase, AE will increase. (same as before, multiplier effect) Multiplier for taxes, -MPC/(1-MPC) [different from govt spending]

How does the Fed use expansionary monetary policy during a recession to reduce unemployment?

IS decreased therefore Real GDP less than potential therefore output gpa is less than 0. Fed must expansionary MP therefore real interest rate decreases and movement along IS If an autonomous variable changes, then we will get a shift in the iS curve

What is the effect of an increase in transfer payments? What is the multiplier? How does it compare to the multiplier for government spending?

If TR increase, disposable income goes up. Same effect as taxes but this time C increases goes up by MPC*TR, so multiplier for TR = MPC/(1-MPC Some TR automatic (e.g. unemployment benefits) If congress makes a discrete change to the policy, then this can be counted in discretionary policy

What is the effect of a decrease in corporate taxes?

If taxes decrease, user cost of capital will fall. Desired capital stock will rise, investment will equal the difference between desired capital stock and actual, investment will increase, AE will increase and the IS curve will increase,

What is the effect of an increase in G on AE, Y & IS? What is the formula for the multiplier?

Overall output increases after multiplier effect. Change in output = change in spending * multiplier (1/1-MPC). IS (C + I + G + NX as a function of r) curve shifts right. Output will increase

How does the Fed use contractionary monetary policy to fight inflation?

To reduce the inflation rate, the Fed increases the interest rate, causing the MP curve to shift up. And the inflation decreases Decrease output when? When output is above potential output. This leads to rising inflation so contractionary policy counteracts that. Contractionary = raise the federal funds rate, increase short-term nominal interest rate, IS up, Y > Yp, output gap r >0, pi>pie