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

Introduction

• Presented by Job Breed from ReviewEcon.com
• Focus on long-term consequences of monetary and fiscal policy
• Content relates to the total review booklet from ReviewEcon.com

Key Concepts

• Monetary Policy: Actions by the central bank to control the money supply and interest rates.
• Fiscal Policy: Government actions regarding taxation and spending.
• AS-AD Model: Aggregate Supply-Aggregate Demand model used to illustrate economic concepts.

Expansionary Policies

• Expansionary Fiscal Policy: Increases in government spending or reductions in taxes.
  • Shifts aggregate demand (AD) curve to the right.
  • Increases price level and real output.
• Expansionary Monetary Policy: Lowering interest rates.
  • Increases gross investment.
  • AD curve shifts right, increasing price level and real output.
• Effects:
  • Aggregate demand increases.
  • Price level and real GDP increase.
  • Unemployment decreases due to inverse relationship with real GDP.
  • Interest rates indeterminate due to conflicting effects.

Contractionary vs. Opposing Policies

• Contractionary Monetary Policy: Raises interest rates, reduces investment, shifts AD left.
• Expansionary Fiscal vs. Contractionary Monetary:
  • Indeterminate effect on price level, real output, and unemployment.
  • Interest rates increase due to fiscal policy demands for loans.

Long-Run Effects of Money Supply Increase

• Money Supply Increase: Decreases interest rates, increases investment, shifts AD right.
• Long-Run Outcome:
  • Price level increases; wages and resource prices rise.
  • Short-run aggregate supply shifts left.
  • No change in real output; higher price levels.

Monetary Equation of Exchange

• Equation: MV = PY
  • M = Money supply
  • V = Velocity of money
  • P = Price level
  • Y = Real output/Real GDP
• Implications:
  • Stable velocity and price level mean increase in output requires more money supply.

National Deficit vs. National Debt

• National Debt: Accumulation of deficits and surpluses.
  • Over $27 trillion.
• Budget Deficit: Tax revenue < government spending.
  • Raises national debt.
• Budget Surplus: Tax revenue > government spending.
  • Lowers national debt.

Crowding Out Effect

• Government deficit leads to higher interest rates.
• Decreases gross investment, capital formation.
• Illustrations in loanable funds market:
  • Shift supply curve left or increase demand for funds.

Economic Growth

• Definition: Increase in potential GDP or per capita GDP.
  • Measured by sustained increases in per capita GDP.
• Factors:
  • Quantity and quality of resources: land, labor, capital.
  • Productivity influences: specialization, human capital, technology.
• Models:
  • AS-AD: Rightward shift of long-run supply curve.
  • Production Possibilities Curve: Outward shift.

Policies for Economic Growth

• Government-funded research, investment tax credits, job training programs.
• Supply-side policies: deregulation, corporate tax cuts.

Phillips Curve

• Short-Run: Inverse relationship between inflation and unemployment.
  • Downward sloping curve.
• Long-Run: Relationship breaks down; vertical curve at natural unemployment rate.
• Shifts:
  • AD shifts mirror movements; supply shifts are mirrored oppositely.
  • Long-run curve shifts with changes in frictional/structural unemployment.

Conclusion

• Comprehensive review of monetary and fiscal policy impacts.
• Encouragement to explore additional resources and activities for mastering the material.