Econ Chapter 15

What are some of the problems neo-classical economist have with the use of stabilization policies?

1) they think the government borrowing to pay for expansionary fiscal policies can negatively impact the capital stock and therefore reduce economic growth

How do we return to full employment from a recession?

As the level of price decreases, the short-run aggregate supply curve shifts downward over time toward full employment. because decreases in wages lowers cost for firms. lower cost lead to lower prices if output is less than full employment, prices will fall as fall as the economy returns to employment

Define Crowding out

Crowding out is a situation where personal consumption of goods and services and investments by business are reduced because of increases in government spending and deficit financing sucking up available financial resources and raising interest rates.

How did Keynes argue against this?

He said if customers increased their savings, there was no guarantee that investment spending would rise to offset the decrease in consumption. And if total spending did fall short of total demand, goods and services would go unsold. When producers could not sell their goods, they would cut back on production and output in the economy would fall as well leading to a recession.

Explain how the money demand graph, employment graph, and investment spending graph go together when we are trying to recover from a recession

If we are in a recession, where actual unemployment exceeds natural unemployment, so there will be excess unemployment. Wages and prices will start to fall which lowers the price level on the unemployment graph. Then the lower price level leads to a lower demand for money because people need less money in order to buy things so they have the demand for a lot of it. With a lower demand for money, interest rates fall because people don't demand as many loans. With lower interest rates, there is higher investment spending.

Neo-classical economist are more concerned about ____lags verus ____ lags in the implementation of ____ policy than in the implementation of _____ policy

Inside lags versus outside lags in the implementation of fiscal policy than in the implementation of monetary policy

Do classical economist believe that there can be situations in which total demand falls short of total production in the economy for extended periods of time?

No they don't, they believe that the increase in savings would eventually find its way to an equivalent increase in investment spending by firms because savings by households would eventually get channeled to firms via financial markets. As a result, spending on consumption and investment together would be sufficient so that all the goods and services produced in the economy would be purchased `

How can demand policies prevent a wage-price spiral if the economy is producing at a level of output above full employment?

Rather than letting an increase in wages and prices bring the economy back to full employment, we can reduce aggregate demand. To do this, we can use either contractionary monetary policy (open market sales) or contractionary fiscal policy (cuts in government spending or tax increases

Which is the best example of the political business​ cycle?

The President pursues a tax​ cut, wins​ re-election, and then pursues a tax hike.

How do we return to full employment from a boom?

Wages and prices rise, an upward direction of the wage-spiral begins if output exceeds full employment, prices will rise and output will fall back to full employment

How long does it take the economy to move from the short-run to the long-run?

about 2-6 years

In the long​ run, increasing the money supply will

do nothing but increase price level

Aggregate supply in the short run reflects the idea that

prices do not change very much in the short run and firms will adjust production to meet demand.

Reasons Keynes doubted that the economic could recover from a major recession without active policy?

the adjustment process requires that interest rates fall an thereby increase investment spending. But suppose that nominal interest rates become so low that they could not fall any further. This is called the liquidity trap. This means that the adjustment process would no longer work. The second reason is that falling prices could hurt business

what are some of the actions policymakers can make to guide the economy back to full employement?

1) do nothing- allow the economy to adjust itself with falling wages and prices until it returns by itself to full-employment. during this time the economy will experience excess unemployment and a level or real output below potential 2) use expansionary policies- such as open market purchases by the Fed or increases in government spending and tax cuts- to shift the aggregate demand curve to the right

What policies can the Gov do to beat a liquidity trap?

1) expansionary fiscal policies such as cutting taxes or raising government spending 2) Fed could very aggressively increase the money supply so the public begins to anticipate inflation. If the public expects inflation, then the expected real rate of interest can become negative, even if the nominal rate cannot fall below zero. A negative expected real interest rate will tempt firms to invest and this will increase aggregate demand.

Long-Run neutrality

A change in the supply of money has no effect on real interest rates, investment or output in the long run

Milton​ Friedman's views on economic policy were greatly influenced by his interpretation of the Great Depression. He argued that the Great Depression was caused by government mismanagement of the money supply. ​Friedman's interpretation of history led him to advocate which of the following economic policies in times of​ recession?

A. The Federal Reserve should increase the money supply to stimulate investment. B. The Federal Reserve should reduce the money supply to discourage future inflation. C. The government and the Federal Reserve should do​ nothing, as activist policies may do more harm than good. D. The government should use activist policies such as tax cuts or government spending increases.

Regarding​ Say's law, John Maynard Keynes argued that

A. there is no guarantee that savings will equal investment. B. producers will cut back production when they can not sell their goods causing output to fall. C. there could be situations in which total demand falls short of total production in the economy for extended periods of time. D. All of the above.

How does an decrease in government spending lead to increased investment spending (crowding in).

As the government decreases their spending, real GDP decreases which causes prices to fall, the demand for money to fall, and interest rates to fall. So investment spending increases.

Explain what crowding out is

Crowding out is a situation where personal consumption of goods and services and investments by business are reduced because of increases in government spending and deficit financing sucking up available financial resources and raising interest rates.

Advocates for the housing industry​ (an industry very sensitive to interest​ rates) might want to advocate lower government spending for the long term. Which of the following would explain why a decrease in government spending would be desirable for the housing industry in the long​ run? Government spending is neutral in the long​ run, so it cannot affect the economy. B. People buy​ houses, not​ governments, so less government spending will benefit the housing industry. C. Decreases in government spending decrease​ GDP, which is good for the housing industry. D. Decreases in government spending can reduce interest rates and crowd in investment. E. Government spending is​ inflationary, so people will purchase real​ assets, such as housing.

D) Decreases in government spending can reduce interest rates and crowd in investment.

Countries that have high money growth for long periods do not grow more rapidly than countries with low money growth. Which of the following best explains​ this?

High rates of money growth are usually inflationary rather than expansionary

Explain how crowding out takes place?

If we start at full employment, an increase of government spending raises output above full employment. This causes wages and prices to increase, the demand for money increases because people need more money to buy goods and this leads to higher interest rates and reduces investment spending. The economy will eventually go back to full employment but at higher interest rates and lower investment spending. As r rises, the dollar appreciates and nx falls. C might also fall as borrowing cost rise.

Neo-classical economist are more concerned about the _______ caused by expansionary monetary policy because why?

Inflation because they expect other nominal variables such as wages, interest rates to quickly adjust to their equilibrium values

What happens if the economy has higher employment than the natural rate and is overheating>

Prices and wages will rise which leads to higher demand for money and higher interest rates which lowers investment spending.

Crowding out in the long-run

Starting at full employment, an increase in government spending raises output above full employment. As wages and prices increase, the demand for money increases, raising interest rates and reducing investment spending. The economy eventually returns to full employment but at a high level of interest rates and at a lower level of investment spending.

What do classical economist believe about demand for total goods and services?

That there can never been a shortage of demand for total goods and services in the economy nor any excess

Read this over and over

The short run in macro-economics is the period of time over which prices do not change or change very much. Over time though, wages and prices adjust and the economy reaches its long-run equilibrium. The long run in macroeconomics is the period of time in which prices have fully adjusted to any economic changes. In the short run, GDP is determined by the current demand for goods and services in the economy so fiscal policy -such as tax cuts or increased government spending -and monetary spending -such as adjusting money supply- can affect demand and GDP. However, in the long run, GDP is determined by the supply of labor, the stock of capital and technological progress- in other words the willingness of people to work and the overall resources the economy has to work with. Full employment is another characteristic of the long run. Because the economy is operating at full employment in the long run, output can't be increased in response to the changes in demand. So, for example, an increase in government spending wont increase GDP in the long run because spending on one good or service has to come at the expense of another good or service. Similarly, increasing the supply of money won't increase GDP in the long-run either. It will only cause the price level in the economy to increase.

an increased foreign demand for US assets means that foreigners buy more what? which causes what

US dollars in order to use them to buy our financial assets which causes the dollar to depreciate

appreciation of the US dollar hurts who?

US exporters because our goods are very expensive in comparison to foreign goods because we can buy more foreign goods (imports) because they are inexpensive to us.

An expansionary fiscal policy that increases government borrowing will cause what?

US interest rates to rise in the long run (more demand for loans drives up their cost )

Define political business cycle

Using monetary or fiscal policy in the short run to improve a politicals reelection prospects An example would be using expansionary policies before the election to lower unemployment and then have to use contractionary policies after the election due to higher prices and crowding out `

What is the long-run neutrality of money

When the economy returns to full employment, the levels of real interest rates, investment, and output are precisely the same as they were before the Fed increased the supply of money. The increase in the supply of money had no effect on real interest rates, investment, or output in the long run. Basically this means that increasing or decreasing the supply of money has no effect on anything except for prices in the long-run

What is classical economics often referred as and what doctrine does it have?`

as "Say's Law" and with the doctrine that supply-creates its own demand.

In the long-run why does it really not matter how much money is in circulation?

because prices will adjust to the amount of nominal money available.

Neo-keynesians worry more about the over-use of _____ by politicans who have a re-election rather than economic tradeoffs in mind

fiscal policy

Why do wages and prices sometimes fall together? (wage-price spiral)

if the economy is producing at a level above full employment, firms will find it increasingly difficult to hire and retain workers, and unemployment will be below its natural rate. Workers will find it easy to get and change jobs. To attract workers and prevent them from leaving, firms will raise their wages. As one firm raises its wage, other firms will ave to raise their wages even higher to attract the works that remain. As labor cost increase, firms have no choice but to increase the prices of their products.

higher US rates of return (on investment) do what?

increases foreign demand for US assets.

Aggregate demand shows the relationship between

level of prices and quantity of real GDP demanded

Neo-keynesians worry more about the over-use of ____policy because its hard to get _____ to go below zero

monetary policy because its hard to get interest rates to go below 0.

Classical economics is often associated with​ Say's law, which states

supply creates its own demand

Which of the following are factors that effect GDP in the long​ run?

supply of​ labor, stock of​ capital, technological progress

Suppose the economy is in a recession and a liqudity trap. Policymakers can

use expansionary fiscal policy such as cutting taxes or increasing government spending.

When output exceeds full​ employment, prices will

​rise, and output will fall back to full employment.