Chapter 9: More on Macroeconomic Theory and policy Flashcards
What are the 3 AD curve effects?
- Interest Rate effect
- Wealth effect
- International trade effect
What is the Wealth effect?
Prices dropping increases the amount of consumption for the same income so in real terms consumers are better off.
Change in price level -> change in real wealth -> change in consumption spending -> change in aggregate spending
What is the interest effect?
Interest rates might be decreased which will stimulate investment spending.
Change in price level -> change in interest rates -> change in investment spending -> change in aggregate spending
What is the international trade effect?
Lower interest rates might result in capital outflows in search of higher interest rates - also lower capital inflows.
Higher demand for foreign currency and lower demand for the rand.
Weaker rand will boost exports and decrease imports.
Increase in domestic goods and services.
Change in price of domestic compared to foreign goods will reinforce the above.
Change in price -> change in interest rates -> change in exchange rate -> change in net exports -> change in aggregate spending
What causes a shift and what causes a movement along the curve?
Price levels cause movement along the curve.
Non-price determinants cause a shift.
The long run AS curve is not impacted by price.
Monetary and fiscal policy is also known as…
Demand management
When is expansionary monetary policy not effective?
When the interest elasticity of investment demand is small and the AS curve is steep.
What are the objectives of South African monetary policy?
Main features:
Ultimate objective is balanced and sustainable economic growth
Intermediate objective is the pre-announced inflation target
Operational variable is repo rate
Monetary control system is classical cash reserve system
- Minimum cash reserve of 2.5% of deposits
- If under -> liquidity shortage
- Central bank uses open market to create a shortage
- Central bank then provides cash reserves to banks through repo system
- Repo impacts short term interest rates
- Short term interest impacts available credit
What to repo changes impact?
Repo rate change impacts:
Domestic interest rate
Quantity of money
Expectations
Asset prices
Exchange rates
What are the 4 lags associated with monetary and fiscal policy?
- Recognition: Time between change and recognising that change has occurred. Economic data isn’t immediately available - time to compile national accounts. Applies to monetary and fiscal policy.
- Decision: Fiscal lag is longer than monetary lag due to the time it takes to make fiscal changes vs monetary changes. Fiscal usually once a year.
- Implementation: Fiscal longer (taxes), approvals etc. Monetary short, overnight.
- Impact: Taxes are indirect, take time to reach the economy. Government spending direct, quicker. Outside impact and monetary policy’s impact takes 12 - 18 months to see.
What is the final goal of policy?
A balanced budget. Government spending is financed through taxes.
What are the beliefs of supply-side economics supporters?
Government spending is too high and spending is better done by the private sector.
Deregulation for entrepreneurs.
Lower taxes
What are the beliefs of new classical economists?
Macro is simply made up of the parts of micro.
Believe that all agents have rational expectations and markets are always clear.
What is new Keynesian economics?
Believe mostly in rational expectations.
Market economy is imperfect.
