Macroeconomics Unit 5: Long-Term Consequences of Monetary and Fiscal Policy Actions

Overview

• Focus on long-term impacts of monetary and fiscal policy actions.
• Applies concepts from previous units in new contexts.

Interaction Between Monetary and Fiscal Policy

Expansionary Policies

• Expansionary Fiscal Policy: Increases government spending or consumption, shifting the aggregate demand (AD) curve to the right.
  • Results: Higher price levels, increased real output, decreased unemployment.
• Expansionary Monetary Policy: Lowers interest rates, increasing gross investment, also shifting AD to the right.
  • Results: Similar effects on price level and output as fiscal policy.
• Interest Rates:
  • Lowered by monetary policy but increased by fiscal policy due to higher national debt and demand for loans.
  • Overall interest rate effect is indeterminate.

Contractionary vs. Opposing Policies

• Contractionary Monetary + Expansionary Fiscal:
  • Contractionary monetary policy raises interest rates, shifting AD left.
  • Expansionary fiscal policy shifts AD right.
  • Net effect on AD, price level, and real output is indeterminate.
  • Interest rates are likely to increase.

Long-Run Effects of Increased Money Supply

• Increased money supply decreases interest rates, boosting investment and shifting AD right.
• Long-term results:
  • Higher price levels.
  • No change in real output.

Monetary Equation of Exchange

• Equation: MV = PY
  • M: Money supply
  • V: Velocity of money
  • P: Price level
  • Y: Real output (Real GDP)
• Implications:
  • Stable V and P allow increased Y with higher M.
  • Both sides of the equation equal nominal GDP.

National Deficit vs. Debt

• National Debt: Accumulation of all surpluses and deficits.
• Deficit: Occurs when government spending exceeds taxes.
  • Raises national debt, causes crowding out (higher interest rates, lower investment).
• Surplus: Taxes exceed spending.
  • Lowers debt, boosts investment, and supports economic growth.

Economic Growth

• Defined: Increase in potential GDP or per capita GDP, not just more GDP.
• Sources:
  • Quantity and quality of resources (land, labor, capital).
  • Productivity (output per labor hour).
• Government Policies:
  • Research funding, tax credits, job training, deregulation.

The Phillips Curve

• Short-Run: Inverse relationship between inflation and unemployment; shown as a downward-sloping curve.
• Long-Run: Vertical curve at the natural rate of unemployment.
  • Inflationary and recessionary gaps illustrated by shifts on the curve.
• Changes:
  • AD shifts cause movement along the short-run curve.
  • Short-run aggregate supply shifts mirror shifts in the corresponding Philips curve.

Conclusion

• Understanding these concepts prepares you for exams and practical application in analyzing economic policies.
• Additional resources and review materials are available to reinforce learning.