11. Monetary and Fiscal Policy Flashcards
what happens to the demand of money when the interest rate rises?
opportunity cost of holding money increases (more could be earned in interest) so demand for money decreases
theory of liquidity: important factor, statement and assumptions
INTEREST RATE. statement: interest rate adjusts to balance the supply and demand for money. There is an equilibrium interest rate at which money demanded equals money supplied
assumptions:
price level is fixed.
what happens and explain what happens to aggregate demand when the price level goes up? (also interest rate)
price level increases -> demand of money increases -> (increases the equilibrium interest rate) -> interest rate increases, so money is now expensive (expensive to borrow, better to save) -> so the price of goods and services decreases
what happens to aggregate demand when interest rates are reduced (ie by the NZRB)
interest rate reduces -> C increases, I increases so Aggregate demand increases (AD = C I G NX)
what happens to commercial banks when the OCR is reduced?
they keep less reserve and money multiplier increases, they loan more money (as it is cheaper to borrow from the RB)
how does the reserve bank implement a monetary injection
reduce OCR
changing money supply and taxes, what kind of policies? also what kind of influence?
monetary, fiscal (taxes).
indirect because it depends on the consumers and investors
multiplier effect of government purchases
ie if the government contract a bridge:
expenditure of government goes through economy: contractors -> suppliers (have to INVEST to expand to provide enough cement and steel) (INVESTMENT ACCELERATOR)
also workers get more money, spend more on other businesses, and these businesses might invest
formula of multiplier effect and what this means
Multiplier = 1/(1-MPC). The aggregate demand and GDP increases by this factor for every injection of government spending, pushing the increase in aggregate demand further than the demand initially created by the government
why is this multiplier effect not fully realized?
increase in government spending causes INTEREST RATE to rise (aggregate demand increases so money market demand increases), high interest rate reduces Investment Spending (and people save more) so this shifts aggregate demand to the left. This effect is called the crowding-out effect
what affects the effect of tax cuts?
perceptions of people (permanency), if they think it is long term they will spend it
mutliplier and crowding out effect
what are automatic stabilizers?
TAXES. IE in recession income reduces so taxes reduce.
GOVERNMENT SPENDING. as people lose jobs, government spends more through welfare.
who’s a faggot?
yea
