Intermediate macroeconomics

    Cards (80)

    • L = kY - hi
      L - Money demand (liquidity)
      kY - transactions demand varies positively with income, Y
      hi - speculative demand varies inversing with nominal interest rate, i
    • kY
      Transactions demand varies positively with income, y
      Increase in income, more money, higher demand = positive relationship
      With sensitivity k (income elasticity of money demand)
      Bank of England works on the assumption k=1
    • hi
      Speculative demand varies inversely with nominal interest rate, i
      increase i - if interest rates increase bonds become more desirable
      Decrease L (demand for money is going to fall)
      Negative relationship
      With sensitivity, h (interest elasticity of money demand)
      Nominal interest rate is the quoted interest rate not the same as real interest rate as that is nominal interest rate - rate of inflation
    • Money supply (M) is controlled by central bank
      • policy variable
      • exogenous - not determined by anything else in the system
      • not dependent on i, Y
    • Increase Y - Increase L - L > M - Increase i
      Increase income - Increase liquidity - liquidity > money supply - increase interest rate
    • Downward sloping money supply curve
      Increase M - Decrease i
      Increase money supply, interest rates will fall
    • Y = AE
      AE = Planned or aggregate expenditure
    • Closed economy
      Y = C + I + G
      C - consumption
      I - Physical capital investment
      G - Government spending
    • Consumption
      C = cY
      c - marginal propensity to consume
      Y - sensitivity
      Typically a high number such as 0.9
    • Investment (I) (physical capital)
      I = ī - bi
      ī - autonomous investment
      b - interest elasticity of investment - (typically 0.5 can vary)
      i - Interest-sensitive investment - Investment is inversely related to the normal interest rate (cost of investment)
      Increase interest rate - more costly for firms to expense - leads to a fall in investment
    • Government spending
      Financial
      1. taxes today (e.g. income tax, t)
      2. Issue bonds (borrows), B - taxes tomorrow
      3. Seigniorage (printing money) - increase 5% - π increase 5% - inflation tax
    • b - 0, di/ dY = ∞ Vertical IS curve
      b - ∞, di/dY = 0 Flat IS curve
    • So if inflation is 0 then nominal is the same as real interest rate
      With this we are assuming that prices are fixed. This is fine if we are in a recession (If prices are fixed there is no inflation (0)) .
    • What would happen with a fall in the interest rate?
      Increase in investment
    • Why is the IS curve downward sloping?
      fall in the interest rate thus would simulate investment and because investment is a component of GDP, GDP will rise
      Decrease nominal interest rate (i) - Increase investment (I) - Increase Output (Y)
    • Increase government spending ?
      G0 - G1
      This shifts the IS curve outwards due to an increase in G
      Would be disappointed if a rise in government spending doesn't lead to an increased output
    • Government spending (G) only affects the IS curve
      Money supply (M) affects the LM curve
    • What happens if you increase money supply (M) ?
      M0 - M1
      Only changes the LM curve
      A rise in M shifts the LM curve in a positive direction
    • An expansionary money policy leads to an increase in GDP (similar to fiscal policy).
    • In a recession you need to boost government spending and money supply
    • Money policy is effective but leads to a fall in interest rates. This is neither good nor bad globally it depends on the person in the situation
    • what happens when b tends to infinity ?(Monetary policy)

      Flat IS as b is tending to infinity
      Monetary policy is very effective and there is no change in interest rate
    • What happens when b tend 0 ?(Monetary policy)
      Vertical IS
      Interest rate has fallen however there is no change in output this means that this monetary policy is ineffective
    • What happens what b tends to infinity ? (fiscal policy)
      Flat IS
      Fiscal policy is ineffective
    • What happens when b tends to 0? (Fiscal policy)
      Vertical IS
      Fiscal policy is effective when it is vertical subject to the normal caveat of the crowding out effect.
    • What happens when h tends to infinity ? Monetary policy
      Flat LM
      Monetary policy is ineffective (liquidity trap)
      Zero - lower bound problem
    • What happens when h tends to 0 ? Monetary policy
      Vertical LM
      Output increases and has the normal falling interest rates so it is effective (classical view)
    • What happens when h tends to infinity ? Fiscal policy
      Flat LM
      Not only is there an increase in output but there is also no crowding out (keynesian view)
    • What happens when h tends to 0 ? Fiscal policy
      Vertical LM
      Output has no change and all the government spending has passed through to the interest and then us complete crowding out. (classical view) Ineffective
    • Limitations
      Fixed prices - inflation assumed to be zero π = inflation
      r = i - π
      As inflation is 0 then the equation is r = i
      This is so we can draw IS and LM on the same diagram (i on the vertical axis)
    • fe = full employment
      Yfe = output at full employment (the maximum a country can actually produce)
    • Counterargument to if fixed prices are a limitation
      There are independent central banks which target inflation
      It is based on the Taylor rule:
      • this says that if inflation increases higher than 2% then they will look at increasing interest rates.
      • This bank will look at the economy to see whether increasing interest rates is suitable
    • If there is no interaction with the money market (no exchange in interest rate then we can see that it is a basic multiplier )(didn't take into account that the LM curve will move)
    • Nominal exchange rate - the price of one unit of foreign currency in terms of the domestic currency - E
      Uk - Norway. E = 0.08. costs 8 pence to buy 1 krone
      (UK / US media: often use inverse definition)
      1/E = 12 12 kroners to £1
    • Real exchange rate (R)
      R = EP^w / P
      nominal x relative price level
    • Purchasing power parity (PPP) - R = 1
    • Rise and falls
      appreciation fall in E
      Real appreciation fall in R
      A fall in R is the domestic currency is "less competitive" ("stronger")
      [fix : revaluation]
      depreciation rise in E
      Real depreciation rise in R
      This means the the domestic currency is "more competitive" (weaker)
      [fix : devaluation]
    • Imports (IM)
      IM = m,Y
      m = marginal propensity to import MPM
      m2R - real exchange rate sensitivity of imports
      Decrease in R is less competitive (our goods more expensive compared to foreign goods) - increase IM
    • Exports (EX)
      EX = x1Y* + x2R
      x2R - real exchange rate sensitivity of exports - increase in EX
      Increase R more competitive (i.e cheaper than others)
    • Balance of payments
      BP = CA + CP + OR
      current account + capital account + official reserves
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