Chapter 18: IS-MP Analysis: Interest Rates & Output
Low interest rate make the US dollar cheaper
and this increases net exports (exports-imports)
Lower interest rates ______ net exports
boost
potential output is determined by long-run factors that are unaffected by these
business cycle changes
When output is less than aggregate expenditure,
businesses will ramp up production so as not to miss out on profitable sales
aggregate expenditure is boosted
by lower real interest rates
Potential GDP is unchanged so
changes in GDP translate to change in the output GAP
In short run, changes in demand drives
changes in output
Lower interest rates boost
consumption
On average, lower interest rates lead to more
consumption
In the short run, ________ conditions determines output
demand
The IS curve is like a macroeconomic
demand curve
Equilibrium GDP
describes the level of GDP at the point of macroeconomic equilibrium - the point at which the economy will come to rest (output level - aggregate expenditures)
High interest rates
discourage spending
The opportunity cost principle tells you
if you should invest or save
government purchases are boosted by
lower interest rates
An economic slump can be in equilibrium because
businesses don't want to produce output that people won't buy, and people don't want to spend more because the economy is weak
The key idea is that when the total quantity of output exceeds aggregate expenditure,
businesses will cut back their production
The real interest. rate represents the opportunity cost of boosting this year's
consumption spending
Lower real interest rates yield more
consumption, investment, government purchases, and net exports
The IS curve is _________ because lower interest rates boost aggregate expenditures, which leads. to a higher level of GDP, and hence a more positive output gap.
downward sloping
The IS curve is valuable tool in forecasting
economic conditions
Low interest rates
encourage spending
Businesses adjust output to meet demand to be in
equilibrium
Aggregate expenditure describes
everyone's spending plans
Supply driven long-run analysis
explains the economy's potential output
The IS curve shows that lower interest rates lead to
higher real GDP and a more positive output GAP
When the Federal Reserve wants to stimulate spending
it lowers the real interest rate
Lower interest rates lead to increased government spending because the government is spending ______ on interest
less
A ________________ in the US leads international money managers to send their funds to other countries that other better returns. This means ______ dollars are need to invest in overseas funds. The dollar becomes ______. So initial effect of a _________ is that it takes fewer yen, euros, pesos, yuan to buy US $
low real interest rate, fewer, cheaper, lower interest rate
______ interest rates lead to a cheaper dollar, causing exports to _______ and imports to ________ and hence _______ net exports.
lower, rise, fall, higher
Output gap
measures the gap between actual and potential output as a percentage of potential output
Low interest rates leads to
more consumption
Real interest rate is
nominal interest rate adjusted for inflation
The real interest rate is central to your spending decisions as a consumer because of the ___________. You save and earn interest on any income you don't spend
opportunity cost principle
Since potential is unchanged, the interest-rate-induced increase in output also increases
output relative to potential output, leading to a more positive output gap
As with the demand. curve, the vertical axis shows ______ and the horizontal axis shows _______, the output gap (quantity of goods and services purchased across the whole economy relative to potential output)
price, quantity
The cheaper dollar _____ imports and _______ exports
reduces, increases
Equilibrium GDP describes the economy's _________ while potential GDP is where _______ wishes it would rest
resting point, Goldilocks
The supply side typically grows _____ over time
smoothly
potential output describes
the economy's maximum sustainable rate of output
On the IS curve graph, the output gap, which is on ___________ measures output relative to potential GDP
the horizontal
If the real interest rate is low, people will by cars with loans because
the interest will be low
The lower the real interest rate is,
the lower the opportunity cost
The aggregate expenditure equation simply states that across the whole economy, businesses will adapt their production so that
total output matches total spending
Analysis of Business Cycles
focus on demand side of economy first
Long-run economic growth
focuses on the supply side of the economy. It is a period spanning a decade or more
The IS curve is called the IS curve because it describes investment and spending decisions __________________ of output
interest sensitive
The boost of investment is usually the most important because
investment is particularly sensitive to the interest rate
actual output
may fail to meet the potential output as aggregate expenditure ebbs and flows
When output goes from -2% to -3% below potential output, it is a more ______ output gap
negative
macroeconomic equilibrium
occurs when the quantity of output that buyers collectively want to purchase is equal to the quantity of output that suppliers collectively produce
When output is below ______, the economy is running too cold. When the output exceeds potential, it risks ______. Only when output is equal to potential output will __________ declare that business cycle conditions are just right
potential, overheating, Goldilocks
Focusing on the output gap is helpful because it provides a way to disentangle the roles of
the demand and supply side determinants of GDP
_____________ may be to most important price in the economy beach it represent the opportunity cost of spending
the real interest rate
The IS curve describes the link between
the real interest rate and the output
Business do more capital spending/investment in machinery and equipment/buildings if
the real interest rates are low because the cost of capital is cheaper
aggregate expenditure
the total amount of goods and services that people want to buy across the whole economy
On the IS curve graph, the real interest rate is on
the vertical axis
short-run refers to
the year-to-year ups and downs of the business cycle
The only time low interest rates don't spur government spending is when
they decided to pay government debt
Everyone spends more when there are low interest rates except the elderly because
they rely on high interest rates to give them interest on their retirement funds (there only source of income
If you can predict demand you can do a great job
forecasting short run fluctuations
Forecasting GDO is all about
forecasting what will happen to each component of aggregate expenditure
Aggregate expenditures can differ from _______ if people purchase less than they produce, the extra goods are kept in _______. This is not an ______ because managers will respond by cutting back production
outputs, inventories, equilibrium
When output goes from -3% to -2% below potential output, it is a more ______ output gap
positive
Do not confuse equilibrium GDP with
potential GDP
The supply side determines
potential output
The real interest rate, which is denoted by r, tells you
how large this opportunity cost is
IS curve
illustrates how lower interest rates raise spending and hence GDP, leading to a more positive output gap
supply side of the economy
is the available supply of labor, capital, and human capital, plus the production function that summarizes the state of technological progress
Potential GDP
is the economy's highest sustainable level of production, and it determined by available inputs
output =
((Actual output - potential output) / potential output) x 100
Y / AE (Aggregate Expenditure) =
C (Consumption) + I (Planned Investment) + G (Government) + NX (Net Exports)
_____________ factors can drive actual GDP to deviate substantially from potential GDP and the actual output gap can fluctuate ________
Demand side, widely
IS curve means
Investment and Spending decisions
You can forecast the output gap based on
a real interest rate
GDP =
aggregate expenditure
output is the same as
aggregate expenditure
potential output is the level at which
all resources are fully employed
Real interest rate
determines this years aggregate expenditures
Lower interest rates boost
investment
When actual GDP exceeds potential GDP, the economy will
overheat
planned investment
when businesses purchase new capital
consumption
when households buy goods and services
The output gap focuses on
the balance between supply and demand
consumption =
Planned Investment+Government Purchases + Net exports
The federal Reserve raises the real intent rate, which ___________ the opportunity cost of spending when it wants to induce people to spend ________
increases, less
Lower interest rates reduce the cost of _______ on government debt. As a result the government has more of its _______ for spending on roads, bridges, etc.
interest payments, budget
potential output
is the economy's maximum sustainable level of output
A rise in aggregate expenditures is matched by a rise in _________ hence GDP
production
Aggregate expenditures might be greater than production if
sales exceed inventories and companies need to ramp up production
government purchases
when the government buys goods and services
potential output definition
is determined by the available supply of labor, human, and physical capital, and technological progress
The real interest rate is also critical because its
one of the levers (tools) policy makers (The Federal Reserve) use to influence the economy
demand side
short-run focuses on aggregate expenditures and its components
In order to keep up with demand, companies must defer maintenance on machinery ____________. But producing at this level is not ___________ and the pressures will spark _______
so they can run extra overnight shifts and running overtime, sustainable, inflation
net exports
spending by foreigners on American-made exports, less spending on foreign-made imports
The real interest rate is the opportunity cost of
spending money this year
Output may be less than potential and still be in equilibrium if
suppliers adjust their production lines (shut id inventories are high enough to cover demand) based on demand)
The real interest is also
the cost of borrowing
