Macroeconomics Unit Five Notes

5.1 Interaction of Monetary and Fiscal Policy

• Expansionary Policies:

  • Monetary Policy:

    • Lower interest rates increase gross investment.

    • Shifts aggregate demand curve (AD) to the right.

  • Fiscal Policy:

    • Increase in government spending or consumption shifts AD to the right.

• Effects:

  • Price level increases.

  • Real GDP output increases.

  • Unemployment rate decreases (inverse relationship with GDP).

• Conflict in Interest Rates:

  • Expansionary monetary policy decreases interest rates;

  • Expansionary fiscal policy can lead to increased national debt, raising demand for loans, increasing interest rates.

  • Overall, interest rates and gross investment become indeterminate.

5.2 Opposite Directions in Policy

• Contractionary Monetary & Expansionary Fiscal:

  • Impact on AD:

    • Contractionary monetary policy raises interest rates, decreasing investment, shifting AD left.

    • Expansionary fiscal policy shifts AD right.

  • Net Effect:

    • Indeterminate price level, real output, and unemployment.

• Interest Rates:

  • Contractionary monetary policy increases interest rates due to higher demand for loans.

  • Gross investment decreases, reducing economic growth.

5.3 Long-Run Effects of Increased Money Supply

• Increases in money supply lead to lower interest rates.

• Results in higher gross investment, shifting AD right.

• Higher price levels lead to increased costs for companies, shifting short-run aggregate supply (SRAS) left.

• Outcome: Long-run equilibrium returns to original GDP output with a higher price level (PL).

5.4 Monetary Equation of Exchange

• Equation: $MV = PY$ - Variables:

  • $M$ - Money Supply

  • $V$ - Velocity of Money (number of times spent per year)

  • $P$ - Price Level

  • $Y$ - Real Income (Real GDP)

• Implications: Stable velocity and price level mean higher real output needs higher money supply.

• Possible to increase money supply with a stable price level and decreasing velocity.

5.5 National Deficit vs. National Debt

• National Debt: Accumulation of past surpluses and deficits (over $27 trillion).

• Budget Deficit: Occurs when government spending exceeds tax revenues, increasing national debt.

• Budget Surplus: Occurs when tax revenues exceed spending, reducing national debt.

5.6 Crowding Out

• Occurs due to budget deficits:

  • Higher interest rates decrease gross investment.

  • Less capital formation leads to lower economic growth.

• Illustration in Loanable Funds Market:

  • Shift left in supply curve (less available for private businesses).

  • Increased demand for loanable funds due to government borrowing.

• Budget Surplus Effects:

  • Decreases interest rates and increases gross investment, boosting economic growth.

5.7 Economic Growth

• Measure of potential GDP increase, focusing on quality and quantity of resources.

• Impacts:

  • Quality Enhancements: Skill increase, better technology.

  • Productivity measured as output/hour.