This document discusses key concepts related to monetary policy, fiscal policy, and aggregate demand. It defines terms like the theory of liquidity preference, fiscal policies, multiplier effect, and crowding-out effect. It explains John Maynard Keynes' ideas about macroeconomics and the relationship between interest rates, money supply, money demand, and price levels. It also outlines how fiscal policies and government spending can impact aggregate demand through the multiplier effect and how crowding-out occurs when fiscal expansion raises interest rates. Automatic stabilizers are also introduced as changes in fiscal policy that stimulate aggregate demand during recessions.

1. Chapter 35
Monetary Policy
Fiscal Policy
and
Aggregate Demand

2. Key Terms
theory of liquidity preference
fiscal polices
multiplier effect
crowding-out effect
automatic stabilizers

3. Economic Cycle

4. Aggregate Demand
Wealth Effect
Interest-Rate Effect
Exchange-Rate Effect

5. John Maynard Keynes
(1883 - 1946)
Father of Macroeconomics
The GeneralTheory of
Employment,
Interest and Money
The ideas of economists and political
philosophers are more powerful than
commonly understood; indeed the
world is ruled by little else.

6. Theory of Liquidity
Preference
Interest rates adjust to
bring money supply and
money demanded into
balance

7. Interest Rates
Nominal = Real + Inflation
If inflation is zero, then
nominal = real

8. Money Supply
Discount Rate
Bond Market
Reserve Ratio

9. Interest
Rate
Quantity of MoneyMD1
Money Market
MD2
r1
r2
Money
Supply
Money
Demand
Quantity fixed
by the Central
Bank
Equilibrium
Interest
Rate

10. Liquidity Theory
1. Money Supply is fixed by central bank with
policy tools (Debt Instrument Market, Discount
Rate, Reserve Requirement)
2. Money Demand - Liquidity - Interest rate is
the opportunity cost of holding money.
3. Equilibrium pressures

11. Interest
Rate
Quantity of Money
Money Market
r2
Money
Supply
Money
Demand
Quantity fixed
by the Central
Bank
r1
r3

12. Money
Demand
Interest
Rate
Quantity of Money
Money Market
r2
Money
Supply
Quantity fixed
by the Central
Bank
r1
r3

13. Money
Demand
Interest
Rate
Quantity of Money
Money Market
r2
Money
Supply
r1
r3

14. Interest
Rate
1. Price level increases
2. Increases demand for money
3. Increases interest rate
4. Reduces quantity demand of output
Money Market
r2
Money
Supply
Money
Demand
Quantity
fixed by the
Central Bank
r1
Price
Level
P2
Aggregate
Demand
OutputY2
P1
Y1
Aggregate Demand

15. Fiscal Policies
Level of government
spending and taxing

16. Multiplier Effect
Additional shifts in
aggregate demand due to
expansionary government
spending

17. Marginal Propensity to Consume
MPC
New income = spend + save
How much do you spend?
75 percent
Then you will be saving 25 percent

18. Marginal Propensity to Consume
plus
Marginal Propensity to Save
equals one
MPC + MPS = 1
1- MPS = MPC
1- MPC = MPS

19. Earn Spend Total Spending
1 100.0 75.0 75.0
2 75.0 56.3 131.3
3 56.3 42.2 173.4
4 42.2 31.6 205.1
5 31.6 23.7 228.8
6 23.7 17.8 246.6
7 17.8 13.3 260.0
8 13.3 10.0 270.0
9 10.0 7.5 277.5
10 7.5 5.6 283.1
11 5.6 4.2 287.3
Multiplier
1/(1-MPC)
Remember
1-MPC = MPS
Therefore
Multiplier
also
1/MPS

20. MPC MPS Total Spending
1.00 0.00 infinite
0.90 0.10 10.00
0.80 0.20 5.00
0.75 0.25 4.00
0.60 0.40 2.50
0.50 0.50 2.00
0.40 0.60 1.67
0.30 0.70 1.43
0.25 0.75 1.33
0.10 0.90 1.11
0.50 0.50 2.00
Multiplier
1/(1-MPC)
Remember
1-MPC = MPS
Therefore
Multiplier
also
1/MPS

21. Multiplier Effect
1.Works with C, I, G, and
NX
2. Goes both ways

22. Where does the money
come from?
Tax
Borrow
Print
Reduces Income
Increases interest
Inflation

23. Crowding-Out can be
larger than the
Multiplier
Aggregate Demand shifts
left

24. Crowding-out Effect
Offsetting aggregate
demand when fiscal
expansion raises interest
rates and reduces spending

25. Automatic Stabilizers
Changes in fiscal policy that
stimulate aggregate demand
when the economy goes
into a recession