Lecture 11 Macroeconomic Policy in Demand Manageme

MacroeconomicsLecture11MacroeconomicPolicyI.IntroductionTheobjectivetostudyhowmacroeconomicpoliciescanbeappliedtosolvepracticalmacroeconomicproblems.II.DemandManagementasAnObjectiveThreebasicmacroeconomicproblemsUnemployment;Inflation;Recession(reflectedaslowlevelinGDP）II.DemandManagementasAnObjectiveThecausesofmacroeconomicproblemsAccordingtotheAS-ADmodel,thesethreeproblemscanallbeexpressedasaninappropriatebalancebetweenaggregatedemandandaggregatesupply,givenastableaggregatesupplycurve.II.DemandManagementasAnObjectiveThecausesofmacroeconomicproblems(continued)Inparticular,unemploymentandrecessionoftenindicatesaninsufficiencyinaggregatedemandwhileinflationoftenindicatestoomuchaggregatedemand.II.DemandManagementasAnObjectiveTheObjectiveofMacroeconomicPolicyThisseemstosuggestthattheobjectiveofmacroeconomicpoliciesistoadjusttheaggregatedemandtowardsitsappropriatelevel.Therefore,themacroeconomicpolicyasproposedbyKeynesisoftennamedasdemandmanagementpolicy.II.DemandManagementasAnObjectiveExpansionaryversusContractionary:Amacroeconomicpolicythatincreasestheaggregatedemandisconsideredtobeanexpansionary(oraggressive)policyAnexpansionarypolicyisoftenappliedwhentheeconomyisinrecession(lowoutput,lowinflationandhighunemploymentrate)II.DemandManagementasAnObjectiveExpansionaryversusContractionary(countinued):Amacroeconomicpolicythatreducestheaggregatedemandisconsideredtobeacontractionarypolicy.Acontractionarypolicyisoftenappliedwhentheeconomyisinexpansion(highoutput,highinflationandlowunemploymentrate)III.MonetaryPolicyTherearetwotypesofmacroeconomicpolicy:Thefiscalpolicy;Themonetarypolicy.EitherofthemcanbeexpansionaryorcontractionaryMonetarypolicyisexecutedbycentralbankIII.MonetaryPolicyTherearebasicthreeinstrumentsofmonetarypolicy:openmarketoperation•Buyingorsellingthegovernmentbond•Whygovernmentbond?changediscountrate;changerequiredreserveratio.III.MonetaryPolicyExpansionaryMonetaryPolicybuyingbond;reducediscountrate;reducerequiredreserveratio.Oftenimpliesastimulationtoincreasemoneysupply(loan).III.MonetaryPolicyContractionaryMonetaryPolicysellingbond;increasediscountrate;increaserequiredreserveratio.Oftenimpliesamotivationtodecreasemoneysupply(loan).III.MonetaryPolicyTheeconomiceffectofchangingmoneysupplyConsiderachange(increase)inM,denotedasM.ItwillfirstshifttheLMcurveintheIS-LMmodel(seethefigureinthenextpage)III.MonetaryPolicyTheeconomiceffectofchangingmoneysupply(continued)III.MonetaryPolicyTheeconomiceffectofchangingmoneysupply(continued)TheshiftinLMcurveindicatesthatatthegivenpricetheoutputwillbeincreasedandthereforetheaggregatedemandcurvewillbeshifttotheright(seethenextpage)III.MonetaryPolicyTheeconomiceffectofchangingmoneysupply(continued)III.MonetaryPolicyTheeconomiceffectofchangingmoneysupply(continued)ThenewequilibriuminAS-ADmodelfurtherindicatesthatthepricewillincreaseandthereforetheLMcurveintheIS-LMmodelshouldbeshiftedbacktotheleft(seethefigureinthenextpage)III.MonetaryPolicyTheeconomiceffectofchangingmoneysupply(continued)III.MonetaryPolicyTheeconomiceffectofchangingmoneysupply(continued)Theoveralleffect•Interestratedecrease(why?)•Investmentincrease•Outputincrease•PriceincreaseThemechanism:pleaseunderstanditasdetailaspossible.IV.FiscalPolicyFiscalPolicyisexecutedbygovernment(ministryoffinance)Therearetwobasicinstruments:changegovernmentexpenditure;changetaxrate.IV.FiscalPolicyExpansionaryFiscalPolicyreducetax;increasegovernmentexpenditure;oftenusedwheneconomicisinrecession;oftenimpliesabudgeddeficitIV.FiscalPolicyContractionaryFiscalPolicyincreasetax;reducegovernmentexpenditure;oftenusedwheneconomicisinexpansion;oftenimpliesabudgetsurplus.IV.FiscalPolicyThreewaysoffinancinggovernmentspending:issuingbond;printingmoney(seignorage);tax.IV.FiscalPolicyCrowdingoutandcrowdingineffectCrowdingouteffect:Crowdingineffect:ifinvestmentalsodependsonoutput:(,);/0,/0IfiYfifYIV.FiscalPolicyCombinationoffiscalandmonetarypolicyIV.FiscalPolicyDebtandsustainabilityTheproblemofdebtindevelopedcountries(seefigure17-3Whyshallwecare?•Argumentfromrationalexpectationassumption:effectingthewelfareofourchildren,itevenhavenoimpacttothecurrenteconomy.•Anotherviewpoint:itmayimpactthenormalfunctionofgovernmentIV.FiscalPolicyMayhavesupplyeffect,dependingonthewayofspendingDemandpullversussupplydrivenSupplysideofeconomicsMayeffecttheeconomicgrowthinthelongrunIV.FiscalPolicyAutomaticStabilizerAsystemoraprogramthatreducestheamplitudeofeconomicfluctuationswithoutregularanddeliberatechangesineconomicpolicy.Forexample,theunemployment-insurancesystemandthewelfareprogramwillautomaticallyraisethetransferpaymentswhentheeconomymovesintoarecession.IV.FiscalPolicyNon-linearityandliquiditytrapTheefficiencyofmonetaryandfiscalpolicydependsontheslopesofrelatedcurves,IS,LM,ASandAD.Thisindicatesthatthenon-linearityoftherelatedcurvescouldbeimportantindeterminingtheeffectivenessofmonetaryandfiscalpolicy.IV.FiscalPolicyNon-linearityandliquiditytrap(continued)IV.Fisca