Integration of Goods and Financial markets Flashcards
Endogenous variables when both are integrated
Y and R. All others are set from outside
How does a gov spending increase ripple through other markets?
G up leads to an increase in Y, which creates a higher transaction demand for money, so people have to sell bonds to get more money. This lowers bond prices, which raises the interest rate. That has two effects: lowering I a bit, decreasing Y, and decreasing the price of bonds until demand and supply are equal. You end up at Y3 which is higher than Y1 and a higher interest rate and greater money supply.
How is the change in multiplier associated w/ income induced respending?
There is an income induced negative respending effect because people want to invest less when the interest rate is higher. This happens financial markets raise rates in response to Y up.
How much does I depend on R?
Depends on V. Keynesians believe V is small. Conservatives believe it is high enough that any dollar in gov spending increase results in a dollar less investment. (Need price adjustment to make this case).
How would a Ms increase trickle through the markets?
When people have more money they want to buy some bonds. This drive the price of bonds up and the interest rate down. Lower interest rate produces more investment and higher Y. Investors will start demanding fewer bonds and will want to hold more money to wait until interest rates increase again. Bond supply will then equal bond demand.
What do Keynesians believe about M-Policy?
Effective but weak compared to just having the government buy more stuff. (because V is small so investment won’t increase by that much).
Keynes Effect (downward sloping AD curve)
If we put a price up shock on the markets, then people will need more money to buy stuff, and will sell bonds. This drives the interest rates up, and the economy slows down because investment decreases. Therefore AD is down from where it was at a lower price level, ergo downward sloping curve.
How does the smaller multiplier effect the response of economy to shocks?
Makes moves in either direction smaller because investment is supposedly opposite changes in Y.
