Cuoi Ky Vi Mo

Chapter 6
The Monetary System
N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or 1
posted to a publicly accessible website, in whole or in part.
The Meaning of Money
• Barter
– Exchanging one good or service for
another
– Trade requires double coincidence of
wants
• Unlikely occurrence that two people each
have a good or service that the other wants
• Money
– Makes trade easier
The Meaning of Money
• Money
– Set of assets in an economy
– That people regularly use
– To buy goods and services from other
people
• Liquidity
– Ease with which an asset can be
converted into the economy’s medium of
exchange
The Functions of Money
1. Medium of exchange
– Item that buyers give to sellers when they
want to purchase goods and services
2. Unit of account
– Yardstick people use to post prices and
record debts
3. Store of value
– Item that people can use to transfer
purchasing power from the present to the
future
The Kinds of Money
• Commodity money
– Money that takes the form of a commodity
with intrinsic value: gold, cigarettes
• Intrinsic value
– Item would have value even if it were not
used as money
• Gold standard - Gold as money
– Or paper money that is convertible into
gold on demand
The Kinds of Money
• Fiat money
– Money without intrinsic value
– Used as money because of government
decree
– “This note is legal tender for all debts,
public and private”
• Fiat
– Order or decree
Money in the U.S. Economy
• Money stock
– Quantity of money circulating in the
economy
• Currency
– Paper bills and coins in the hands of the
public
• Demand deposits
– Balances in bank accounts; depositors
can access on demand by writing a check
Money in the U.S. Economy
• Measures of money stock
– M1
• Demand deposits, Traveler’s checks
• Other checkable deposits, Currency
– M2
• Everything in M1
• Savings deposits, Small time deposits
• Money market mutual funds
• A few minor categories
Figure 1 Two Measures of the Money Stock for the
U.S. Economy
N. Gregory Mankiw, Principles of Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or
posted to a publicly accessible website, in whole or in part. 9
The Federal Reserve System
• Central bank
– Institution designed to
• Oversee the banking system
• Regulate the quantity of money in the economy
• The Federal Reserve (the Fed)
– The central bank of the United States
– Created in 1913 after a series of bank failures
in 1907
– Purpose: to ensure the health of the nation’s
banking system
Banks and the Money Supply
• Money
– Currency + Demand deposits
• Behavior of banks
– Can influence the quantity of demand
deposits in the economy (and the money
supply)
“I’ve heard a lot about

money, and now I’d like
to try some.”
Banks and the Money Supply
• Reserves
– Deposits that banks have received but
have not loaned out
• The simple case of 100% reserve banking
– All deposits are held as reserves
• Banks do not influence the supply of money
Fractional-Reserve Banking
• Fractional-reserve banking
– Banks hold only a fraction of deposits as
reserves
• Reserve ratio
– Fraction of deposits that banks hold as
reserves
• Reserve requirement
– Minimum amount of reserves that banks
must hold; set by the Fed
• Excess reserve
– Banks may hold reserves above the legal
minimum
• Example: First National Bank
– Reserve ratio 10%
• Banks hold only a fraction of deposits in
reserve
– Banks create money
• Assets
• Liabilities
– Increase in money supply
– Does not create wealth
The Money Multiplier
• The money multiplier
– Original deposit = $100.00
– First National lending = $ 90.00 [= .9 × $100.00]
– Second National lending=$ 81.00 [= .9 × $90.00]
– Third National lending = $ 72.90 [= .9 × $81.00]
–…
– Total money supply = $1,000.00
• The money multiplier
– Amount of money the banking system
generates with each dollar of reserves
– Reciprocal of the reserve ratio = 1/R
• The higher the reserve ratio
– The smaller the money multiplier
Fed’s Tools of Monetary Control
• Influences the quantity of reserves

– Open-market operations
– Fed lending to banks
• Influences the reserve ratio
– Reserve requirements
– Paying interest on reserves
Fed’s Tools of Monetary Control, Part 2
• Open-market operations
– Purchase and sale of U.S. government
bonds by the Fed
– To increase the money supply
• The Fed buys U.S. government bonds
– To reduce the money supply
• The Fed sells U.S. government bonds
– Easy to conduct
– Used more often
• Fed lending to banks

• To increase the money supply
• Discount window
• At the discount rate
– Term Auction Facility
• To the highest bidder
• The discount rate

– Interest rate on the loans that the Fed
makes to banks
– Higher discount rate
• Reduce the money supply
– Smaller discount rate
• Increase the money supply
• Term Auction Facility (2007 to 2010)

– The Fed sets a quantity of funds it wants
to lend to banks
– Eligible banks bid to borrow those funds
– Loans go to the highest eligible bidders
• Acceptable collateral
• Pay the highest interest rate
• Reserve requirements
– Minimum amount of reserves that banks
must hold against deposits
• An increase in reserve requirement: decrease
the money supply
• A decrease in reserve requirement: increase
the money supply
– Used rarely – disrupt business of banking
– Less effective in recent years
• Many banks hold excess reserves
• Paying interest on reserves

– Since October 2008
– The higher the interest rate on reserves
• The more reserves banks will choose to hold
– An increase in the interest rate on
reserves
• Increase the reserve ratio
• Lower the money multiplier
• Lower the money supply
Problems
• The Fed’s control of the money supply
– Not precise
• The Fed does not control:
– The amount of money that households
choose to hold as deposits in banks
– The amount that bankers choose to lend
Bank Runs and the Money Supply
• Bank runs
– Depositors fear that a bank may be
having financial troubles
• “Run” to the bank to withdraw their deposits
– Problem for banks under fractional-
reserve banking
• Cannot satisfy withdrawal requests from all
depositors
• When a bank run occurs

– The bank - is forced to close its doors
– Until some bank loans are repaid
– Or until some lender of last resort
provides it with the currency it needs to
satisfy depositors
– Complicate the control of the money
supply
• Great Depression, early 1930s

– Wave of bank runs and bank closings
– Households and bankers - more cautious
– Households
• Withdrew their deposits from banks
• Great Depression, early 1930s

– Bankers - responded to falling reserves
• Reducing bank loans,
• Increased their reserve ratios
• Smaller money multiplier
• Decrease in money supply
• No bank runs today

– Depositors are confident
– FDIC will make good on the deposits
• Government deposit insurance
– Guarantees the safety of deposits at most
banks: Federal Deposit Insurance
Corporation (FDIC)
– Cost: Bankers - little incentive to avoid bad
risks
– Benefit: A more stable banking system
The Federal Funds Rate
• The federal funds rate
– Interest rate at which banks make
overnight loans to one another
• Lender – has excess reserves
• Borrower – needs reserves
– A change in federal funds rate
• Changes other interest rates
• The federal funds rate
– Differs from the discount rate
– Affects other interest rates as well
– Is determined by supply and demand in
the market for loans among banks
– Targeted by the Fed
• Change the federal funds rate
• Change the money supply
• The Fed targets the federal funds rate
through open-market operations
– The Fed buys bonds
• Decrease in the federal funds rate
• Increase in money supply
– The Fed sells bonds
• Increase in the federal funds rate
• Decrease in money supply
Chapter 7
Money Growth and Inflation
Inflation
• Inflation
– Increase in the overall level of prices
• Deflation
– Decrease in the overall level of prices
• Hyperinflation
– Extraordinarily high rate of inflation
Inflation
• 2008 to 2018
– Prices rose at an average rate of 1.5% per
year
• The 1970s
– Prices rose by 7.8% per year
– The price level more than doubled over
the decade
Inflation
• International data, 2018 inflation rate
– 2.4% in the U.S
– 1.2 percent in Japan
– 4.8 percent in Mexico
– 12 percent in Nigeria
– 15 percent in Turkey
– 32 percent in Argentina
• February 2008, Zimbabwe
– 24,000% (hyperinflation)
The Classical Theory of Inflation
• Classical theory of money

– Quantity theory of money
– Explain the long-run
determinants of the price level
– Explain the inflation rate
“So what’s it going to
be? The same size as
last year or the same
price as last year?”
Level of Prices; Value of Money
• Inflation
– Economy-wide phenomenon
– Concerns the value of economy’s medium
of exchange
• Inflation: rise in the price level
– Lower value of money
– Each dollar buys a smaller quantity of
goods and services
• Money demand
– Reflects how much wealth people want to
hold in liquid form
– Depends on
• Credit cards
• Availability of ATM machines
• Interest rate
• Average level of prices in economy
– Demand curve – downward sloping
• Money supply
– Determined by the Fed and the banking
system
– Supply curve is vertical
• In the long run
– Money supply and money demand are
brought into equilibrium by the overall
level of prices
Supply and Demand for Money
Value of Price level, P

money, 1/P
As the value of
money increases,
1 1
the price level
decreases
¾ 1.33
½ 2
¼ 4
Amount of
money
CHƯƠNG
posted to7 a– publicly
TỐC ĐỘaccessible
TĂNG TIỀN VÀ LẠM
website, PHÁTor in part.
in whole
Value of
Price level, P
money, 1/P MS1
1 1
¾ 1.33
Central Bank sets
MS at fixed value
½ 2
(MS does not
depend on P)
¼ 4
$1000 Amount of
money
CHƯƠNG
in whole
Value of
money, 1/P Level price, P
A decrease in the value of
money (or an increase in
P) increases the quantity
1 demanded of money 1
¾ 1.33
½ 2
¼ 4
MD1
Amount of
money
CHƯƠNG
in whole
Figure 1 How the Supply and Demand for Money
Determine the Equilibrium Price Level
Effects of a Monetary Injection
• Economy is in equilibrium
– If the Fed doubles the supply of money
• Prints bills
• Drops them on market
– Or the Fed: open-market purchase
– New equilibrium
• Supply curve shifts right
• Value of money decreases
• Price level increases
Figure 2 An Increase in the Money Supply
• Quantity theory of money

– The quantity of money available in the
economy determines (the value of money)
the price level
– Growth rate in quantity of money available
determines the inflation rate
• Adjustment process
– Excess supply of money
– Increase in demand of goods and services
– Price of goods and services increases
– Increase in price level
– Increase in quantity of money demanded
– New equilibrium
Classical Dichotomy
• Nominal variables
– Variables measured in monetary units
• Dollar prices
• Real variables
– Variables measured in physical units
• Relative prices, real wages, real interest rate
• Classical dichotomy
– Theoretical separation of nominal and real
variables
Classical Dichotomy
• Developments in the monetary system
– Influence nominal variables
– Irrelevant for explaining real variables
• Monetary neutrality
– Changes in money supply don’t affect real
variables
– Not completely realistic in short-run
– Correct in the long run
Velocity and the Quantity Equation
• Velocity of money (V)

– Rate at which money changes hands
• V = (P × Y) / M
P = price level (GDP deflator)
Y = real GDP
M = quantity of money
Velocity and the Quantity Equation
• Quantity equation: M × V = P × Y
• Quantity of money (M)
• Velocity of money (V)
• Dollar value of the economy’s output of goods
and services (P × Y )
– Shows: an increase in quantity of money
• Must be reflected in:
– Price level must rise
– Quantity of output must rise
– Velocity of money must fall
Figure 3 Nominal GDP, the Quantity of Money, and
the Velocity of Money
Quantity Theory of Money
1. Velocity of money
– Relatively stable over time
2. Changes in quantity of money, M
– Proportionate changes in nominal value of
output (P × Y)
3. Economy’s output of goods & services, Y
– Primarily determined by factor supplies
– And available production technology
– Money does not affect output
Quantity Theory of Money
4. Change in money supply, M
– Induces proportional changes in the
nominal value of output (P × Y)
• Reflected in changes in the price level (P)
5. When the central bank increases the
money supply rapidly
– High rate of inflation
The Inflation Tax
• The inflation tax
– Revenue the government raises by
creating (printing) money
– Like a tax on everyone who holds money
• When the government prints money
• The price level rises
• And the dollars in your wallet are less
valuable
The Fisher Effect
• Principle of monetary neutrality
– An increase in the rate of money growth
– Raises the rate of inflation
– But does not affect any real variable
• Real interest rate = Nominal interest rate
– Inflation rate
• Nominal interest rate = Real interest rate
+ Inflation rate
The Fisher Effect
• Fisher effect
– One-for-one adjustment of nominal
interest rate to inflation rate
– When the Fed increases the rate of
money growth
– Long-run result
• Higher inflation rate
• Higher nominal interest rate
Figure 5 The Nominal Interest Rate and the
Inflation Rate
The Costs of Inflation
• Inflation fallacy
– “Inflation robs people of the purchasing
power of his hard-earned dollars”
• When prices rise
– Buyers pay more
– Sellers get more
• Inflation does not in itself reduce people’s
real purchasing power
The Costs of Inflation
• Shoeleather costs
– Resources wasted when inflation
encourages people to reduce their money
holdings
– Can be substantial
• Menu costs
– Costs of changing prices
– Inflation – increases menu costs that firms
must bear
Relative-Price Variability
• Market economies
– Relative prices allocate scarce resources
– Consumers compare quality and prices of
various goods and services
• Determine allocation of scarce factors of
production
– Inflation distorts relative prices
• Consumer decisions are distorted
• Markets are less able to allocate resources to
their best use
Inflation-Induced Tax Distortions
• Taxes distort incentives

– Many taxes: more problematic in the
presence of inflation
• Tax treatment of capital gains
– Capital gains are profits
• Sell an asset for more than its purchase price
– Inflation discourages saving
• Exaggerates the size of capital gains
• Increases the tax burden
Inflation-Induced Tax Distortions
• Tax treatment of interest income

– Nominal interest earned on savings
• Treated as income
• Even though part of the nominal interest rate
compensates for inflation
• Higher inflation
– Tends to discourage people from saving
Confusion and Inconvenience
• Money
– Yardstick with which we measure
economic transactions
• The Fed’s job
– Ensure the reliability of money
• When the Fed increases money supply
– Creates inflation
– Erodes the real value of the unit of
account
Arbitrary Redistributions of Wealth
• Unexpected inflation
– Redistributes wealth among the
population
• Not by merit
• Not by need
– Redistribute wealth among debtors and
creditors
• Inflation: volatile and uncertain
– When the average rate of inflation is high
Deflation May Be Worse
• Small and predictable amount of deflation
– May be desirable
• The Friedman rule: moderate deflation will
– Lower the nominal interest rate
– Reduce the cost of holding money
– Shoeleather costs of holding money -
minimized by a nominal interest rate close
to zero
• Deflation equal to the real interest rate
Deflation May Be Worse
• Costs of deflation
– Menu costs
– Relative-price variability
– If not steady and predictable
• Redistribution of wealth toward creditors and
away from debtors
– Arises because of broader
macroeconomic difficulties
• Symptom of deeper economic problems
CHAPTER 8
THE OPEN ECONOMY
slid
e0
CHAPTER OBJECTIVES
• accounting identities for the open economy
• small open economy model
 what makes it “small”
 how the trade balance and exchange rate are
determined
 how policies affect trade balance & exchange
rate
slid
e1
I MPORT S AND E XPORT S
AS A PE R CE NTAGE OF OUT P UT: 2 0 00
Percentage40
of GDP
35
30
25
20
15
10
0
Canada France Germany Italy Japan U.K. U.S.
Imports Exports
slid
e2
IN AN OPEN ECONOMY,
• spending need not equal output

• saving need not equal investment
slid
e3
PRELIMINARIES
C C d C f superscripts:
d = spending on
I Id If domestic goods
f = spending on
G G d G f foreign goods
EX = exports =
foreign spending on domestic goods
IM = imports = C f + I f + G f
= spending on foreign goods
slid
e4
PRELIMINARIES , CONT.
NX = net exports (the “trade balance”)

= EX – IM
• If NX > 0,
country has a trade surplus
equal to NX
• If NX < 0,
country has a trade deficit
equal to – NX
slid
e5
GDP = EXPENDITURE ON
DOMESTICALLY PRODUCED G & S
Y  C d  I d  G d  EX
 (C  C f )  (I  I f )  (G  G f )  EX
 C  I  G  EX  (C f  I f  G f )
 C  I  G  EX  IM
 C  I  G  NX
slid
e6
THE NATIONAL INCOME IDENTITY
IN AN OPEN ECONOMY
Y = C + I + G + NX
or, NX = Y – (C + I + G )
domestic
spending
net exports
output
slid
e7
INTERNATIONAL CAPITAL FLOWS
• Net capital outflows

= S –I
= net outflow of “loanable funds”
= net purchases of foreign assets
the country’s purchases of foreign assets
minus foreign purchases of domestic
assets
• When S > I, country is a net lender
• When S < I, country is a net borrower

slid
e8
ANOTHER IMPORTANT IDENTITY
NX = Y – (C + I + G )
implies
NX = (Y – C – G ) – I
= S – I
trade balance = net capital outflows
slid
e9
SAVING AND INVESTMENT
IN A SMALL OPEN ECONOMY
• An open-economy version of the loanable funds model
from chapter 4.
• Includes many of the same elements:
production function: Y  Y  F (K , L )
consumption function: C  C (Y  T )
investment function: I  I (r )
exogenous policy variables: G  G , T  T
slid
e
10
THE NOMINAL EXCHANGE RATE
e = nominal exchange rate,

the relative price of
domestic currency
in terms of foreign currency
(e.g.Yen per Dollar)
slid
e
11
EXCHANGE RATES AS OF JUNE 6, 2002
country exchange rate

Euro 1.06 Euro/$
Japan 124.3 Yen/$
Mexico 9.7 Pesos/$
Russia 31.4 Rubles/$
South Africa 9.8 Rand/$
Turkey 1,444,063.1 Liras/$
U.K. 0.68 Pounds/$
slid
e
12
THE REAL EXCHANGE RATE
ε = real exchange rate,

the relative price of
the lowercase domestic goods
Greek letter in terms of foreign goods
epsilon
(e.g. Japanese Big Macs per U.S.
Big Mac)
slid
e
13
UNDERSTANDING THE UNITS OF Ε
e P
ε 
P *
(Yen per $)  ($ per unit U.S. goods)

Yen per unit Japanese goods
Yen per unit U.S. goods


Yen per unit Japanese goods
Units of Japanese goods


per unit of U.S. goods
slid
e
14
EXAMPLE
• one good: Big Mac

• price in Japan:
P* = 200 Yen
• price in USA:
P = $2.50
• nominal exchange rate
e = 120 Yen/$ To buy a U.S. Big Mac,
e P someone from Japan
ε  would have to pay an
P*
120  $2.50
amount that could buy
  1.5 1.5 Japanese Big Macs.
200 Yen
slid
e
15
Ε IN THE REAL WORLD &
OUR MODEL
• In the real world:

We can think of ε as the relative price of
a basket of domestic goods in terms of a basket
of foreign goods
• In our macro model:
There’s just one good, “output.”
So ε is the relative price of one country’s output
in terms of the other country’s output
slid
e
16
HOW NX DEPENDS ON Ε
ε  U.S. goods become more expensive

relative to foreign goods
 EX, IM
 NX
slid
e
17
U.S. NET EXPORTS AND THE
REAL EXCHANGE RATE, 1975-
2002
2 140
Percent of GDP
1998:2 = 100
1 120
0 100
-1 80
-2 60
-3 40
-4 20
-5 0
1975 1980 1985 1990 1995 2000
Net exports (left scale) slid

e
Real exchange rate (right scale) 18
THE NET EXPORT FUNCTION
• The net export function reflects this inverse

relationship between NX and ε:
NX = NX (ε )
slid
e
19
THE NX CURVE FOR THE U.S.
so U.S. net
When ε is exports will
relatively low, be high
U.S. goods are ε1
relatively
inexpensive NX(ε)
0 NX
NX(ε1) slid
e
20
THE NX CURVE FOR THE U.S.
ε At high enough values

of ε,
U.S. goods become so
ε2 expensive that
we export
less than we
import
NX(ε)
NX(ε2)
0 NX
slid
e
21
HOW Ε IS DETERMINED
• The accounting identity says NX = S  I

• We saw earlier how S  I is determined:
• S depends on domestic factors (output, fiscal
policy variables, etc)
• I is determined by the world interest
rate r *
• So, ε must adjust to ensure
NX (ε )  S  I (r *)
slid
e
22
HOW Ε IS DETERMINED
Neither S nor I
ε S 1  I (r *)
depend on ε,
so the net capital
outflow curve is
vertical.
ε1
ε adjusts to
equate NX NX(ε )
with net capital
NX
outflow, S - I. NX 1
slid
e
23
INTERPRETATION: SUPPLY AND
DEMAND IN THE FOREIGN
EXCHANGE MARKET
demand: ε S 1  I (r *)
Foreigners need
dollars to buy U.S.
net exports.
supply: ε1
The net capital
outflow (S - I ) NX(ε )
is the supply of
NX
dollars to be NX 1
invested abroad.
slid
e
24
FOUR EXPERIMENTS
1. Fiscal policy at home
2. Fiscal policy abroad
3. An increase in investment demand
4. Trade policy to restrict imports
slid
e
25
1. FISC AL POLICY AT HOME
A fiscal expansion S 2  I (r *)
reduces national ε S 1  I (r *)
saving, net capital
outflows, market… ε2
and the supply of
dollars in the foreign
exchange
ε1
NX(ε )
…causing the
real exchange NX
rate to rise and NX 2 NX 1
NX to fall. slid
e
26
2. FISC AL POLICY ABROAD
An increase in r* S 1  I (r1 *)
reduces investment, ε S 1  I (r2 *)
increasing net capital
outflows and the ε1
supply of dollars in
the foreign exchange
market… ε2
…causing the NX(ε )

real exchange NX
rate to fall and NX 1 NX 2
NX to rise.
slid
e
27
3. AN INCREASE IN INVESTMENT
DEMAND
An increase in S1  I 2
investment ε S1  I 1
reduces net capital
outflows and the
ε2
supply
of dollars in the
foreign exchange ε1
market…
NX(ε )
…causing the
NX
real exchange NX 2 NX 1
rate to rise and
NX to fall. slid
e
28
4. TRADE POLICY TO
RESTRICT IMPORTS
At any given value of ε,

an import quota S I
ε
 IM  NX
 demand for
dollars shifts
ε2
right
ε1
NX (ε )2
Trade policy doesn’t
affect S or I , so capital NX (ε )1
flows and the supply of NX
dollars remains fixed. NX1
slid
e
29
4. TRADE POLICY TO
RESTRICT IMPORTS
Results:
ε S I
ε > 0
(demand
increase)
NX = 0
ε2
(supply fixed)
IM < 0 ε1
(policy) NX (ε )2
EX < 0
(rise in ε ) NX (ε )1
NX
NX1
slid
e
30
Chapter 9
Aggregate Demand and Aggregate Supply
Economic Fluctuations
• Economic activity
– Fluctuates from year to year
• Recession
– Economic contraction
– Period of declining real
incomes and rising “You’re fired.
unemployment Pass it on.”
• Depression
– Severe recession
Economic Fluctuations
Three key facts about economic fluctuations
1. Economic fluctuations are irregular and
unpredictable
• The business cycle
2. Most macroeconomic quantities fluctuate
together
• Recessions: economy-wide phenomena
3. As output falls, unemployment rises
Figure 1A Look at Short-Run Economic Fluctuations
Short-Run Economic Fluctuations
• Classical dichotomy
– Separation of variables into:
• Real variables
• Nominal variables
• Monetary neutrality
– Changes in the money supply
• Affect nominal variables
• Do not affect real variables
• Classical theory holds in the long-run

– Changes in money supply
• Affect prices, and other nominal variables
• Do not affect real GDP, unemployment, or
other real variables
• Short-run
– Assumption of monetary neutrality: no
longer appropriate
– Real and nominal variables are highly
intertwined
– Changes in the money supply
• Can temporarily push real GDP away from its
long-run trend
• AD-AS model
– Model of aggregate demand (AD) and
aggregate supply (AS)
– Most economists use it to explain short-
run fluctuations in economic activity
• Around its long-run trend
• Aggregate-demand curve
– Shows the quantity of goods and services
– That households, firms, the government,
and customers abroad
– Want to buy at each price level
– Downward sloping
• Aggregate-supply curve
– Shows the quantity of goods and services
– That firms choose to produce and sell
– At each price level
– Upward sloping
Figure 2 Aggregate Demand and Aggregate Supply
Economists use the model of aggregate demand and aggregate supply to analyze economic
fluctuations. On the vertical axis is the overall level of prices. On the horizontal axis is the
economy’s total output of goods and services.
Output and the price level adjust to the point at which the aggregate-supply and aggregate-
demand curves intersect.
The Aggregate-Demand Curve
Y = C + I + G + NX
• Three effects explain why AD curve
slopes downward:
– Wealth effect (C )
– Interest-rate effect (I)
– Exchange-rate effect (NX)
• Assumption: government spending (G)
– Fixed by policy
• Price level and consumption (C): the

wealth effect
– Decrease in price level
• Increase in the real value of money
• Consumers are wealthier
• Increase in consumer spending
• Increase in quantity demanded of goods and
services
• Price level and investment (I): the

interest-rate effect
– Decrease in price level
• Decrease in the interest rate
• Increase spending on investment goods
services
• Price level and net exports (NX): the

exchange-rate effect
– Decrease in U.S. price level
• Decrease in the interest rate
• U.S. dollar depreciates
• Stimulates U.S. net exports
services
• Summary: a fall in price level

– Increases quantity of goods and services
demanded
– Because:
1. Consumers are wealthier: stimulates the demand
for consumption goods
2. Interest rates fall: stimulates the demand for
investment goods
3. Currency depreciates: stimulates the demand for
net exports
• Summary: a rise in price level

– Decreases the quantity of goods and services
demanded
– Because:
1. Consumers are poorer: depress consumer
spending
2. Higher interest rates fall: depress investment
spending
3. Currency appreciates: depress net exports
Figure 3 The Aggregate-Demand Curve
• The AD curve might shift:

– Changes in consumption, C
– Changes in investment, I
– Changes in government purchases, G
– Changes in net exports, NX
• Changes in consumption, C
– Events that change how much people
want to consume at a given price level
• Changes in taxes, wealth
– Increase in consumer spending
• Aggregate-demand curve: shift right
• Changes in investment, I
– Events that change how much firms want
to invest at a given price level
• Better technology
• Tax policy
• Money supply
– Increase in investment
• Changes in government purchases, G

– Policy makers – change government
spending at a given price level
• Build new roads
– Increase in government purchases
• Changes in net exports, NX

– Events that change net exports for a given
price level
• Recession in Europe
• International speculators – change in
exchange rate
– Increase in net exports
The Aggregate-Supply Curve
• Long run aggregate-supply curve is

vertical, LRAS
– Price level does not affect the long-run
determinants of GDP:
• Supplies of labor, capital, and natural
resources
• Available technology
• Short run
– Aggregate-supply curve is upward sloping
Figure 4 The Long-Run Aggregate-Supply Curve
• Natural level of output

– Production of goods and services
– That an economy achieves in the long run
• When unemployment is at its normal rate
– Potential output
– Full-employment output
• The LRAS curve might shift:

– Any change in natural level of output
– Changes in labor
– Changes in capital
– Changes in natural resources
– Changes in technological knowledge
• Changes in labor
– Quantity of labor – increases
• Aggregate-supply curve: shifts right
– Natural rate of unemployment – increases
• Aggregate-supply curve: shifts left
• Changes in capital
– Capital stock – increase
– Physical and human capital
• Changes in natural resources

– New discovery of natural resource
– Weather
– Availability of natural resources
• Changes in technology
– New technology, for given labor, capital
and natural resources
– International trade
– Government regulation
• Aggregate supply curve slopes upward in

the short-run:
– Price level affects the economy’s output
– Increase in overall level of prices in economy
• Tends to raise the quantity of goods and services
supplied
– Decrease in level of prices
• Tends to reduce quantity of goods and services
supplied
Figure 6 The Short-Run Aggregate-Supply Curve
Causes of Economic Fluctuations
• Assumption
– Economy begins in long-run equilibrium
• Long-run equilibrium:
– Intersection of AD and LRAS curves
• Natural level of output
• Actual price level
– Intersection of AD and short-run AS curve
• Expected price level = Actual price level
Figure 7 The Long-Run Equilibrium
• Shift in aggregate demand

– Wave of pessimism: AD shifts left
– Short-run
• Output falls
• Price level falls
– Long-run
• Short-run aggregate-supply curve shifts right
• Output – natural level
• Price level – falls
Table 3 Four Steps for Analyzing Macroeconomic
Fluctuations
1. Decide whether the event shifts the aggregate-demand

curve or the aggregate-supply curve (or perhaps both).
2. Decide the direction in which the curve shifts.
3. Use the diagram of aggregate demand and aggregate
supply to determine the impact on output and the price
level in the short run.
4. Use the diagram of aggregate demand and aggregate
supply to analyze how the economy moves from its new
short-run equilibrium to its new long-run equilibrium.
Figure 8 A Contraction in Aggregate Demand
Figure 9 U.S. Real GDP Growth since 1900
The Great Recession of 2008–2009, Part 1
• 2008-2009, financial crisis, severe downturn

in economic activity
– Worst macroeconomic event in more than half
a century
• A few years earlier: a substantial boom in
the housing market
– Fueled by low interest rates
• Rise in housing prices
– Developments in the mortgage market
– Other issues
• Developments in the mortgage market

– Easier for subprime borrowers to get loans
• Borrowers with a higher risk of default (income and
credit history)
– Securitization
• Process by which a financial institution (mortgage
originator) makes loan
• Then (investment bank) bundles them together
mortgage-backed securities
• Developments in the mortgage market

– Mortgage-backed securities
• Sold to other institutions, which may not have fully
appreciated the risks in these securities
• Other issues
– Inadequate regulation for these high-risk loans
– Misguided government policy
• Encouraged this high-risk lending
• 1995-2006
– Increase in housing demand
– Increase in housing prices
• More than doubled
• 2006-2009, housing prices fell 30%
– Substantial rise in mortgage defaults and home
foreclosures
– Financial institutions that owned mortgage-
backed securities
• Huge losses
• Large contractionary shift in AD

– Real GDP fell sharply
• By 4.2% between the forth quarter of 2007
and the second quarter of 2009
– Employment fell sharply
• Unemployment rate rose from 4.4% in May
2007 to 10.0% in October 2009
Three policy actions aimed in part at

returning AD to its previous level
1. The Fed
– Cut its target for the federal funds rate
• From 5.25% in September 2007 to about
zero in December 2008
– Started buying mortgage-backed
securities and other private loans
• In open-market operations
• Provided banks with additional funds
2. October 2008, Congress appropriated
$700 billion
– For the Treasury to use to rescue the
financial system
– To stem the financial crisis on Wall Street
– To make loans easier to obtain
– Equity injections into banks
– U.S. government – temporarily became a
part owner of these banks
3. January 2009, Barack Obama

– Large increase in government spending
– $787 billion stimulus bill, February 17,
2009
• June 2009, the meager recovery began
– Second quarter of 2009 to fourth quarter
of 2015
• Real GDP growth averaged only 2.1% per
year
• Unemployment fell to 5.0% by 2016

– Much of the decline: individuals leaving the
labor force
• In December 2015, employment-to-
population ratio
– Only 1.3 percentage points higher than at its
trough during the Great Recession
– More than 3 percentage points lower than
before the downturn began
• Shift in aggregate supply

– Firms – increase in production costs
– Short-run - stagflation
• Output falls, price level rises
– Long-run, if AD is held constant
• Short-run AS shifts back to right
• Price level - falls
Figure 10 An Adverse Shift in Aggregate Supply
Causes of Economic Fluctuations, Part 4
• Shift in aggregate supply

– Firms – increase in production costs
– Short-run
• Output falls
• Price level rises
– Long-run, policymakers – shift AD to right
• Price level – rises
Figure 11 Accommodating an Adverse Shift in Aggregate Supply
Oil and the Economy, Part 1
• Economic fluctuations in the U.S.
– Since 1970, originated in the oil fields of the
Middle East
• Some event - reduces the supply of crude
oil flowing from Middle East
– Price of oil rises around the world
– Aggregate-supply curve shifts left
– Stagflation
• Mid-1970s
• Late-1970s
• Increase the supply of crude oil from Middle East,
1986
– Squabbling among members of OPEC
– Prices fell by about half
– Aggregate-supply curve – shifts right
• Output – rapid growth
• Unemployment – falls
• Inflation rate – falls
Changes in Middle East oil

production are one source of U.S.
economic fluctuations.
• Recent years
– World market for oil – not an important source
of economic fluctuations
– Conservation efforts
– Changes in technology
– Availability of alternative energy sources
• Amount of oil used to produce a unit of real
GDP
– Declined by more than 50% since the OPEC
shocks of the 1970s
Chapter 10
The Influence of Monetary and Fiscal Policy
on Aggregate Demand
Aggregate Demand
• The theory of liquidity preference
– Keynes’s theory
– Interest rate adjusts:
• To bring money supply and money demand
into balance
– Nominal interest rate
– Real interest rate
– Assumption: expected rate of inflation is
constant
Demand and Supply of Money
• Money supply
– Controlled by the Fed
– Quantity of money supplied
• Fixed by Fed policy
• Doesn’t vary with interest rate
– Fed alters the money supply
• Changing the quantity of reserves in the banking
system
– Purchase and sale of government bonds in open-
market operations
3
• Money demand
– Money – most liquid asset
• Can be used to buy goods and services
– Interest rate – opportunity cost of holding money
– Money demand curve – downward sloping
• Increase in the interest rate
– Raises the cost of holding money
– Reduces the quantity of money demanded
• Equilibrium in the money market

– Interest rate – adjusts to balance the supply
and demand for money
– Equilibrium interest rate
– Quantity of money demanded exactly
balances the quantity of money supplied
• If interest rate > equilibrium

– Quantity of money people want to hold
• Less than quantity supplied
– People holding the surplus
• Buy interest-bearing assets
– Lowers the interest rate
– People - more willing to hold money
– Until: equilibrium
• If interest rate < equilibrium

– Quantity of money people want to hold
• More than quantity supplied
– People - increase their holdings of money
• Sell - interest-bearing assets
– Increase interest rates
– Until: equilibrium
Figure 1 Equilibrium in the Money Market
Aggregate Demand
• The downward slope of the AD curve
1. A higher price level
– Raises money demand
2. Higher money demand
– Leads to a higher interest rate
3. A higher interest rate
– Reduces the quantity of goods and services
demanded
Figure 2 The Money Market and the Slope of the
Aggregate-Demand Curve
Monetary Policy Influences AD
• Aggregate-demand curve shifts

– Quantity of goods and services demanded
changes
– For a given price level
• Monetary policy
– Increase in money supply
– Decrease in money supply
– Shifts aggregate-demand curve
• The Fed increases the money supply

– Money-supply curve shifts right
– Interest rate falls
– At any given price level
services
– Aggregate-demand curve shifts right
Figure 3 A Monetary Injection
• The Fed decreases the money supply

– Money-supply curve shifts left
– Interest rate increases
– At any given price level
• Decrease in quantity demanded of goods and
services
– Aggregate-demand curve shifts left
• Federal funds rate

– Interest rate
– Banks charge one another
– For short-term loans
• The Fed: targets the federal funds rate
– The FOMC – open-market operations
• Adjust money supply
• Changes in monetary policy aimed at

expanding aggregate demand
– Increasing the money supply
– Lowering the interest rate
• Changes in monetary policy aimed at
contracting aggregate demand
– Decreasing the money supply
– Raising the interest rate
Fiscal Policy Influences AD
• Fiscal policy
– Government policymakers
– Set the level of government spending and
taxation
• Shift the aggregate demand
– Multiplier effect
– Crowding-out effect
• The multiplier effect

– Additional shifts in aggregate demand
• Result when expansionary fiscal policy
increases income
• And thereby increases consumer spending
• The multiplier effect of an increase in

government purchases by $20 billion
– Aggregate-demand curve
• Shifts right by exactly $20 billion
– Consumers respond
• Increase spending
– Aggregate-demand curve
• Shifts right again
Figure 4 The Multiplier Effect
• Multiplier effect
– Response of consumer spending
– Response of investment
• Investment accelerator
– Higher government demand
• Higher demand for investment goods
– Positive feedback from demand to
investment
• Spending multiplier
– Marginal propensity to consume, MPC
• Fraction of extra income that consumers
spend
– Size of the multiplier
• Depends on the MPC
– A larger MPC
• Larger multiplier
• Spending multiplier = 1/(1 – MPC)

Change in government purchases = $ 20 billion
First change in consumption = MPC2 × $ 20 billion
Second change in consumption = MPC2 × $ 20 billion
Third Change in consumption = MPC3 × $ 20 billion
● ●
● ●
● ●
Total change in demand = (1 + MPC + MPC2 + MPC3
+ …) × $20 billion.
• Because of multiplier effect

– $1 of government purchases
• Can generate > $1 of aggregate demand
– $1 of consumption, investment, or net
exports
• Can generate > $1 of aggregate demand
• The crowding-out effect

– Offset in aggregate demand
– Results when expansionary fiscal policy
raises the interest rate
– Thereby reduces investment spending
• The crowding-out effect of an increase in

government spending
– Aggregate-demand curve – shifts right
• Increase in income
• Money demand – increases
• Interest rate – increases
• Aggregate-demand curve – shifts left
Figure 5 The Crowding-Out Effect
• A decrease in personal income taxes

– Households income – increases
– Multiplier effect
• Aggregate demand – increases
– Crowding-out effect
• Aggregate demand – decreases
– Permanent tax cut – large impact on AD
– Temporary tax cut – small impact on AD

Cuoi Ky Vi Mo

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Cuoi Ky Vi Mo

Uploaded by

Copyright:

Available Formats

Chapter 6

The Monetary System

“I’ve heard a lot about

• Influences the quantity of reserves

• Fed lending to banks

• The discount rate

• Term Auction Facility (2007 to 2010)

• Paying interest on reserves

• When a bank run occurs

• Great Depression, early 1930s

• Great Depression, early 1930s

• No bank runs today

Money Growth and Inflation

• Classical theory of money

Value of Price level, P

• Quantity theory of money

• Velocity of money (V)

• Taxes distort incentives

• Tax treatment of interest income

THE OPEN ECONOMY

• spending need not equal output

NX = net exports (the “trade balance”)

• Net capital outflows

• When S < I, country is a net borrower

e = nominal exchange rate,

country exchange rate

ε = real exchange rate,

Yen per unit U.S. goods

Units of Japanese goods

• one good: Big Mac

• In the real world:

ε  U.S. goods become more expensive

Net exports (left scale) slid

• The net export function reflects this inverse

ε At high enough values

• The accounting identity says NX = S  I

1. Fiscal policy at home

2. Fiscal policy abroad

3. An increase in investment demand

4. Trade policy to restrict imports

…causing the NX(ε )

At any given value of ε,

Aggregate Demand and Aggregate Supply

• Classical theory holds in the long-run

• Price level and consumption (C): the

• Price level and investment (I): the

• Price level and net exports (NX): the

• Summary: a fall in price level

• Summary: a rise in price level

• The AD curve might shift:

• Changes in government purchases, G

• Changes in net exports, NX

• Long run aggregate-supply curve is

• Natural level of output

• The LRAS curve might shift:

• Changes in natural resources

• Aggregate supply curve slopes upward in

• Shift in aggregate demand

1. Decide whether the event shifts the aggregate-demand

• 2008-2009, financial crisis, severe downturn

• Developments in the mortgage market

• Developments in the mortgage market

• Large contractionary shift in AD