12.4 The Strength of Monetary Forces Flashcards
What happens when any AD or AS shock creates an output gap?
Starting from a long-run equilibrium in our macro model with real GDP equal to , any AD or AS shock that creates an output gap sets in place an adjustment process that will eventually close that gap and return real GDP to Potential GDP
What is Long-run money neutrality?
Long-run money neutrality
The idea that a change in the supply of money has no long-run effect on any real variables; it affects only the price level.
When is money neutral in the long run?
Money is neutral in the long run if the only long-run effect of an increase in the money supply is a higher price level.
Money is neutral in the long run if a change in the money supply has no long-run effect on the level of potential GDP or any other real variables. Much empirical evidence is consistent with long-run money neutrality, although the proposition is still debated.
In brief, what is the belief of Classical dichotomy?
The “monetary side” of the economy was independent from the “real side” in the long run. This belief came to be referred to as the Classical dichotomy.
What is the least controversial proposition regarding the neutrility of money?
The least controversial proposition regarding the neutrality of money is that altering the number of zeros on the monetary unit, and on everything else stated in those units, will have no economic consequences.
For example, if an extra zero were added to all Bank of Canada notes—so that all $5 bills became $50 bills, all $10 bills became $100 bills, and so on—and the same adjustment was made to all nominal wages, prices, and contracts in the economy, there would be no effects on real GDP, real wages, relative prices, and other real economic variables.
Whats the second slightly stronger proposition reguarding money neutrality?
A slightly stronger proposition regarding money neutrality is that altering the nature of the monetary unit will have no real economic effects.
Such a change occurred, for example, in 1971, when the United Kingdom changed from a system in which the basic monetary unit, the pound sterling, was composed of 240 pence to its current system which contains 100 pence.
These changes were neither important enough nor long-lasting enough to show up in the macroeconomic data.
What is the third and stronger more controversial prososition reguarding money neutrality?
The stronger and more controversial proposition regarding money neutrality is the one discussed in the text—that the economy’s level of potential output and thus its long-run equilibrium is unaffected by changes in the supply of money.
This assumption is standard in most macroeconomic models because there is much empirical evidence to support it
In brief, what is the hysteresis effect?
Hysteresis—the possibility that short-run changes in real GDP caused by changes in the money supply may have an influence on Y* .
What is a situation where the propsition of long-run money neutrality can be called into question?
Some short-run changes in GDP may be associated with changes in investment or employment that cause long-lasting effects on . In these situations, the proposition of long-run money neutrality is called into question.
What is the relationship between Countries with higher inflation rates and the rates of growth of the money supply?
Countries with higher inflation rates tend to be countries with higher rates of growth of the money supply.
Across many countries over long periods of time, the rate of inflation and the growth rate of the money supply are highly correlated.
What is Monetary policy?
Monetary policy
A central bank’s decisions regarding the money supply and interest rates used in its efforts to influence aggregate demand.
What does the magnitude of the shift in the AD curve in response to an increase in money supply depend on?
How much the AD curve shifts in response to an increase in the money supply depends on the amount of investment expenditure that is stimulated.
The increase in investment expenditure in turn depends on the strength of two of the linkages that make up the monetary transmission mechanism…
The link between money supply and interest rates
The link between interest rates and investment.
How does the steepness of the Monetary Demand curve effect the magnitude of the change in equilibrium interest rate?
How does the slope of the investmend demand curve effect the magnitutde of the change in interest rate?
How does the slope of the Id curve and the Md curve effect the magnitude of changes in interst rate as a result of changes in the money supply?
The ability of monetary policy to induce short-run changes in real GDP depends on…
