slides created by kevin brady and eric chiang monetary policy interactive examples to navigate,...
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Slides Created By
Kevin Brady and Eric Chiang
Monetary Policy
Interactive Examples
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Material from this presentation can be found in:
Chapter 23
CoreEconomics, 2e
Begin
Monetary Policy
AggregatePrice Level
(P)
Aggregate Output (Y)
We introduced the AD/AS model earlier. Recall that the model shows the relationship between the aggregate output of goods and services in the economy and the price level.
Back
Interactive Examples
Question: What establishes long-run macroeconomic equilibrium in an economy?
Answer
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
Answer: Long-run macroeconomic equilibrium occurs at the intersection of the short-run aggregate supply curve (SRAS), the aggregate demand curve (AD), and the long-run aggregate supply (LRAS) curve.
SRAS
AD
LRAS
Next
We introduced the AD/AS model earlier. Recall that the model shows the relationship between the aggregate output of goods and services in the economy and the price level.
Question: What establishes long-run macroeconomic equilibrium in an economy?
Monetary Policy
P0
Y0
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
SRAS0
AD0
LRAS0
Assume the graph to the right represents the U.S economy. Notice that it is in long-run macroeconomic equilibrium.
Monetary Policy
P0
Y0
Question: If there is suddenly a large increase in the demand for U.S. exports, what would happen?
Answer
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
SRAS0
AD0
LRAS0
Next
Assume the graph to the right represents the U.S economy. Notice that it is in long-run macroeconomic equilibrium.
Monetary Policy
P0
Y0
Question: If there is suddenly a large increase in the demand for U.S. exports, what would happen?
Answer: The increase in net exports will cause the AD0 curve to shift to AD1. The new short-run equilibrium is at price level P1 and output level Y1.
AD1
Y1
P1
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
SRAS0
LRAS0
Notice that while the real output level is higher at Y1, there is also a higher price level in the economy at P1.
Monetary Policy
AD1
Y1
P1Question: Suppose the Federal Reserve Bank (the Fed) is worried about inflation. What type of policy could they implement to address this concern?
Answer
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
SRAS0
AD2
LRAS0
Next
Monetary Policy
P0
Y0
AD1
Y1
P1
Question: Suppose the Federal Reserve Bank (The Fed) is worried about inflation. What type of policy could they implement to address this concern?
Answer: The Fed could implement contractionary monetary policies to reduce aggregate demand. They can achieve this by raising interest rates, which would reduce investment, or by selling government bonds, which would reduce the money available for consumption. This would return the economy to long-run equilibrium at P0 and Y0.
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
SRAS0
AD0
LRAS0
Assume the graph to the right represents the U.S economy. Notice that it is in long-run macroeconomic equilibrium.
Monetary Policy
P0
Y0
Question: If firms throughout the economy acquire more market power through deregulation, what effect would this have on our model?
Answer
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
SRAS0
AD0
LRAS0
Next
Assume the graph to the right represents the U.S economy. Notice that it is in long-run macroeconomic equilibrium.
Monetary Policy
P0
Y0
Question: If firms throughout the economy acquire more market power through deregulation, what effect would this have on our model?
Answer: The increase in market power will allow firms to reduce supply and make larger profits. The SRAS curve will shift to the left, resulting in a new short-run equilibrium at price level P1 and output level Y1.
SRAS1
Y1
P1
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
AD0
LRAS0
Notice here we have the worst of both worlds: a higher price level and lower aggregate output!
Monetary Policy
P0
Y0
SRAS1
Y1
P1
Question: What would happen in our model if the Fed implements expansionary monetary policy?
Answer
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
AD0
LRAS0
Next
Notice here we have the worst of both worlds: a higher price level and lower aggregate output!
Monetary Policy
P0
Y0
SRAS1
Y1
P1
Question: What would happen in our model if the Fed implements expansionary monetary policy?
Answer: If the Fed decreased interest rates, the aggregate demand curve would shift to the right.
While aggregate output returns to its full employment equilibrium at Y0, there is now an even higher price level at P2! The gain in output came at the expense of inflation.
AD1
P2
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
AD0
LRAS0
Let’s take a step back and see what happens if the Fed uses a different strategy to cope with the higher price level and lower output level resulting from a negative supply shock.
Monetary Policy
P0
Y0
SRAS1
Y1
P1Question: What would happen in our model if the Fed implements contractionary monetary policy?
Answer
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
AD0
LRAS0
Let’s take a step back and see what happens if the Fed uses a different strategy to cope with the higher price level and lower output level resulting from a negative supply shock.
Monetary Policy
P0
Y0
SRAS1
Y1
P1
Question: What would happen in our model if the Fed implements contractionary monetary policy?
Answer: If the Fed increased interest rates, the aggregate demand curve would shift to the left.
While the price level returns to its original equilibrium, there is now an even lower output level at Y2! The reduction in inflation came at the expense of aggregate output.
Y2
Next
AggregatePrice Level
(P)
Aggregate Output (Y)
Back
Interactive Examples
AD0
LRAS0
Monetary Policy
P0
Y0
SRAS1
Y2
This is why the Fed has a hard job! There is no easy monetary policy solution to an aggregate supply shock.
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