ECO 1002 Final Review Outline

Topics: Inflation, Monetary policy, Bretton Woods system Pages: 5 (2318 words) Published: March 20, 2015

Notes are from Professor Malca’s Lectures and Baumol & Blinder’s Macroeconomics Ch 14: Differing Views on Fiscal and Monetary Policy
Monetary
Velocity indicates the number of times per year that an “average dollar” is spent on goods and services. . Formula: Velocity = Nominal GDP/Money supply
Equation of Exchange: Money Supply x Velocity = Nominal GDP (= Price Level x Real GDP) or M x V = P x Y The quantity of the money supply affects GDP, but not directly. For example, raising the money supply would decrease velocity, canceling out the effects. The quantity theory of money says that velocity stays constant. It rewrites our equation in the in the form of growth rates (percents of change): %ΔM +%ΔV = %ΔP + %ΔY

Says %ΔV = 0 since it’s constant
in reality, not accurate in the short run because velocity isn’t constant Equation of Exchange is still useful, but we have to identify what causes shifts in V Efficiency of the Payments System - with computers money moves rapidly Interest Rates - increasing monetary supply decreases interest rates So if M (monetary supply) is increased, V would decrease (since interest rates are part of V) - so we can’t say nominal GDP will increase if we increase the monetary supply Monetarists believe that if we can figure out V, then we can use M to control GDP they are a competing school of thought to Keynes’ C + I + G + (Ex-Im) might work in the long run, but again, not accurate in the short run Fiscal

Expansionary fiscal policy (more G aka govt spending) raises interest rates, and tighter fiscal policies lower interest rates Because a rise in G causes interest rates to rise, which reduces private investment aka I, the multiplier effect is reduced (the 1/(1-MPC) formula is exaggerated) There are stabilization lags: Fiscal affect aggregate demand through consumer spending more quickly than monetary which affects aggregate demand through investment however there are other lags related to how quickly these measures come into place - the FOMC meets eight times a year for monetary policy, while Congress releases a fiscal policy budget once a year and after political fighting recently the fiscal policy lag has been shorter in 2001, 08, 09 Debate on how the Fed should conduct monetary policy - focus on the rate of interest (r) or controlling bank reserves/money supply (M), which is preferred by monetarists If the demand curve for money shifts outward due to increased output/prices or reserves, the Federal reserve has to choose between controlling r and M the Fed must ultimately tolerate a rise in interest rates, a rise in the money stock, or both. If it solely focuses on M, it can control the supply of money but not the demand due to demand of money shifts, interest rates can fluctuate dramatically if it solely focuses on r, there would be wild contractions of money the money supply would expand during boom times, but fall duirng recessions (when its needed most) - that’s very bad flexible targets are best

historically, the fed prioritizes targeting r since wild fluctuations in rates hurt investment spending Flatness of the Aggregate Supply Curve
If the supply curve is flat, expansionary policy means large gains in real GDP with a law cost to inflation, and contraction policy hurts real output with little price level gains if the supply curve is steep, the opposite is true

shape of supply curve isn’t clear, also varies by different industries Any change in aggregate demand will have most of its effect on output (flat) in the short run but on prices (steep) in the long run. Government Intervention

active vs passive stabilzation policies
lags may make stabilization policy do more harm then good
some say that instead of reacting to the markets, stick to rules that ignore current economic scenarios and allow the market to self correct monetarists believe the money supply should be kept growing at a constant rate do not manage fiscal policy/aggregate demand actively

if we had more accurate...
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