Money, the Interest Rate, and. Analysis and Policy. The Goods Market and the Money Market. The Links Between the Goods Market and the Money Market

Transcription

1 C H A P T E R 24 Money, the Interest Rate, an Output: Prepare by: Fernano Quijano an Yvonn Quijano The Goos Market an the Money Market The goos market is the market in which goos an services are exchange an in which the equilibrium level of aggregate output is etermine. The money market is the market in which financial instruments are exchange an in which the equilibrium level of the interest rate is etermine. 2of 29 The Links Between the Goos Market an the Money Market There is a value of output (income) (Y) an a level of the interest rate (r) that are consistent with the existence of equilibrium in both markets. This chapter examines how monetary an fiscal policies affect the level of output, interest rates, an investment spening. 3of 29

2 The Links Between the Goos Market an the Money Market Planne investment epens on the interest rate an money eman epens on income. 4of 29 Link 1: Income an the Deman for Money Income, which is etermine in the goos market, has consierable influence on the eman for money in the money market. When income falls, the eman for money falls an the interest rate falls. 5of 29 Link 2: Planne Investment an the Interest Rate The interest rate, which is etermine in the money market, has significant effects on planne investment in the goos market. When the interest rate rises, planne investment falls (fewer projects are likely to be unertaken). 6of 29

3 Investment, the Interest Rate an the Goos Market r I AE Y r I AE Y An increase in the interest rate from 3 percent to 6 percent lowers planne aggregate expeniture an thus reuces equilibrium income from Y 0 to Y 1. 7of 29 Equilibrium in the Money Market (review) 8of 29 Money Deman, Aggregate Output (Income), an the Money Market Y M r Y M r Changes in aggregate output (income), which take place in the goos market, shift the money eman curve an cause changes in the interest rate. 9of 29

4 Expansionary Policy Effects Expansionary fiscal policy is either an increase in government spening or a reuction in net taxes aime at increasing aggregate output (income) (Y). Expansionary monetary policy is an increase in the money supply aime at increasing aggregate output (income) (Y). 10 of 29 The Crowing-Out Effect G Y M r I Y increases less than if r i not increase The crowing-out effect is the tenency for increases in government spening to cause reuctions in private investment spening. 11 of 29 The Crowing-Out Effect The crowing-out effect epens on the sensitivity or insensitivity of planne investment spening to changes in the interest rate. Interest sensitivity means that planne investment spening changes a great eal in response to changes in the interest rate. 12 of 29

5 Expansionary Monetary Policy: An Increase in the Money Supply An increase in the money supply ecreases the interest rate an increases investment an income. However, the simultaneous increase in the eman for money keeps the interest rate from falling as far as it otherwise woul. s M r I Y M r ecreases less than if M i not increase 13 of 29 Fe Accommoation of an Expansionary Fiscal Policy An expansionary fiscal policy (higher government spening or lower taxes) will increase aggregate output (income). In turn, higher income will shift the money eman curve to the right, an put upwar pressure on the interest rate. 14 of 29 Fe Accommoation of an Expansionary Fiscal Policy If the money supply were unchange following an increase in the eman for money, the interest rate woul rise. But if the Fe were to accommoate the fiscal expansion, the interest rate woul not rise. 15 of 29

6 Contractionary Policy Effects Contractionary fiscal policy refers to a ecrease in government spening or an increase in net taxes aime at ecreasing aggregate output (income) (Y). G or T Y 16 of 29 Contractionary Fiscal Policy G or T Y M r I The ecrease in Y is smaller when we take the money market into account. 17 of 29 Contractionary Monetary Policy s M r I Y Contractionary monetary policy refers to a ecrease in the money supply aime at ecreasing aggregate output (income) (Y). 18 of 29

7 Contractionary Monetary Policy s M r I Y M Y ecreases less than if r i not ecrease When we take into account the money market, the interest rate will increase by less, an the ecrease in Y will be smaller. 19 of 29 MONETARY POLICY The Macroeconomic Policy Mix The Effects of the Macroeconomic Policy Mix Key: Expansionary ( M s ) Contractionary ( M s ) : Variable increases. : Variable ecreases.?: Forces push the variable in ifferent irections. Without aitional information, we cannot specify which way the variable moves. Expansionary ( G or T) Y, r?, I?, C Y?, r, I, C? FISCAL POLICY Contractionary ( G or T) Y?, r, I, C? Y, r?, I?, C 20 of 29 Other Determinants of Planne Investment The eterminants of planne investment are: The interest rate Expectations of future sales Capital utilization rates Relative capital an labor costs 21 of 29

8 Review Terms an Concepts contractionary fiscal policy contractionary monetary policy crowing-out out effect expansionary fiscal policy expansionary monetary policy goos market interest sensitivity or insensitivity of planne investment money market policy mix 22 of 29 The IS-LM iagram is a way of epicting graphically the etermination of aggregate output (income) an the interest rate in the goos an money markets. 23 of 29 The IS curve shows a negative relationship between the equilibrium value of Y an r. Each point on the curve represents equilibrium in the goos market for a given value of the interest rate. 24 of 29

9 The LM curve shows a positive relationship between the equilibrium value of Y an r. Each point on the curve represents equilibrium in the money market for a given value of aggregate output (income). The LM curve is upwar-sloping because higher income results in higher eman for money an a higher interest rate. 25 of 29 The point at which the IS an the LM curves intersect correspons to the point at which the goos market an the money market are in equilibrium. 26 of 29 An increase in government spening shifts the IS curve to the right. This increases the value of both Y an r. 27 of 29

10 An increase in the money supply shifts the LM curve to the right. In turn, the value of Y increases an the value of r ecreases. 28 of 29 It is easy to use the IS/LM iagram to see how there can be a monetary an fiscal policy mix that leas to a particular outcome. Here, an increase in the money supply accompanie by an increase in government spening leas to an increase in aggregate output, with no change in the interest rate. 29 of 29