Chapter 12 - SR & LR Flashcards
(7 cards)
Short Run and Long Run: What happens with an impact of an Expansionary Fiscal Policy (G↑)?
Short Run:
G increases
Planned Expenditure rises
Inventory levels fall
Output/Income Y rises
Demand for money rises
Demand for bonds fall
People tend to sell bonds
Price of bonds fall
Interest rate rises
Investment falls
Also:
Consumption, C, rises
Unemployment falls
Long Run:
Because in the short run economy is in boom (Y > Ybar)
Price, P, increases over time
Real money supply, M/P shrinks
People tend to sell bonds
Price of bonds fall
Interest rate, r, rises
Investment, I, falls (Crowding Out Effect)
Planned Expenditure Falls
Inventory Levels rise
Output/Income, Y falls to Ybar
Unemployment rises to Un
Short Run and Long Run: What happens with an impact of an Expansionary Monetary Policy (M↑)?
Short Run:
Central bank buys bonds (M↑
Price of bonds rises
Interest rate r, falls
Investment, I, rises
Planned expenditure rises
Inventory levels fall
Output/Income Y rises
Consumption, C, rises
Also: Unemployment falls
Long Run:
Price, P increase over time
Real money supply m/p shrinks
People tend to sell bonds
Price of bonds fall
Interest rate,r, rises
Investment falls
Planned expenditure falls
Inventory levels rise
Output/income, Y, falls to Ybar
Unemployment rises back to Un.
Short Run and Long Run: What happens with impacts of any negative shocks on the goods market like lower consumer sentiment
Short Run:
Lower consumer sentiment
Consumption, c, FALLS
Planned Expenditure falls
Inventory levels rise
Output/Income, Y falls
Demand for money falls
Demand for bonds rises
People tend to buy bonds
Price of bonds rises
Interest rate, r, falls
Investment, I rises
Also: Unemployment rises
Long Run:
Prices, P decrease over time
Real money supply, M/P rises
People tend to buy bonds
Price of bonds rises
Interest rate falls
Investment ries
Planned Expenditure rises
Inventory levels fall
Output/Income, Y, rises to Ybar
Unemployment falls back to Un
Short and Long Run Equilibrium: Draw an adverse supply shock, like bad weather (crop failure)
Short Run:
Price of agricultural product rises
Price level, P, rises
Supply of real money falls
People tend to sell bonds
Price of bonds fall
Interest rate rises
Investment falls
Planned expenditure falls
Output/Income Y falls
Consumption C falls
Unemployment rises
Long Run ( Stagflation: Y < Ybar)
Price, P, decreases
Real Money Supply, M/P rises
People tend to buy bonds
Price of bonds rises
Interest rate falls
Investment rises
Planned Expenditure rises
Inventory levels fall
Output/income level Y rise to Ybar
Unemployment fall back to Un
What is the Pigou Effect, Debt Deflation Theory and Effect of Expected deflation?
Pigou Effect: Lower prices, real money balance rises, people’s wealth rises, higher consumer confidence optimism, higher consumption, higher expenditure/income/output
Debt Deflation Theory: An unexpected deflation: Transfer of income (wealth) from borrowers to lenders, borrowers spend less and lenders spend more. If borrowers have higher propensity to spend, aggregate spending falls (shifts in IS), lower income/output
Effect of Expected deflation: An expected deflation: investors reduce their borrowing and investment, because they know they have to pay back the debt with more valuable dollar in the future, lower expenditure, lower income/output
What is the Spending Hypothesis?
Spending Hypothesis: Shocks to the IS curve
The US stock market crash, reduction in wealth and consumption. A drop in investments, widespread bank failure made it hard to obtain financing for investments
Contractionary Fiscal Policy: Politicians raised tax rates and cut spending to combat increasing deficits. IS curve shifts to the left.
The hypothesis asserts that the Great Depression was largely due to the fall in demand for goods and services, a leftward shift of the IS curve, where output and interest rates both fall.
What is the Money Hypothesis?
Money Hypothesis:
Money Hypothesis 1: Shock to the LM curve
- The hypothesis asserts the great depression was largely due to the huge fall in money supply due to bank failure (bank runs) and the Fed did not do anything.
- Two Problems with this hypothesis:
- Price, P fell even more so M/P actually rose slightly during the period.
- Nominal Interest rate fell, which is the opposite of an upward LM shift
Money Hypothesis 2: The effects of falling prices:
The hypothesis asserts the great depression was largely due to huge deflation
This deflation was probably caused by the fall in M, so perhaps money played an important role after all
A deflation led to lower income/output and higher unemployment:
Negative impact of unexpected deflation (debt deflation theory) on output/income
Negative impact of expected deflations on output/income
