Macro quiz 5/21

How does fiscal policy affect AD

• By controlling directly G

• By affecting C and I through taxes

Expansionary monetary policy

lowers interest rates by open-market purchases of T-bills, while selling reserve to the banking system

• increases AD

Contractionary monetary policy

Increases interest rates by open-market sales of T-bills while buying reserves from the banking system

• reduces AD

Expenditure components most sensitive to monetary policy

• investment (housing investments rely on mortgages)

• consumption (incentive to save depends on interest rates)

If the fed engages in contractionary policy

• higher interest rates

• lower I, lower C

• lower total spending

• lower expenditure schedule

• lower equilibrium level of GDP

• aggregate demand shifts to the left

If fed engages in expansionary policy

• lower interest rates

• encourages investments and consumption

• higher total spending

• higher expenditure schedule

sensitivity of interest rates to open-market operations

• Flatter demand: smaller change in interest rates

• Steeper demand: larger change in interest rates

During Recessions

• Gov should raise G and cut T to restore full employment

• likely to imply G>T, budget deficit

During booms

• Gov should cut G and raise T

• likely to imply G<T, budget surplus

•The government might be able to run a balanced budget (T = G) only if

• starts from balanced one

• gdp is at its potential level

Budget

• flow variable (value related to a specific period of time

National Debt

• total indebtedness of the economy at a moment in time, but accumulated from the past

• stock variable (related to the amount of outstanding public debt)

Governments

• accumulate debt by running budget deficits

• reduce debt by running surpluses