ECO 1002 Final Review Outline
Notes are from Professor Malca’s Lectures and Baumol & Blinder’s Macroeconomics
Ch 14: Differing Views on Fiscal and Monetary Policy
Monetary
Velocity indicates the number of times per year that an “average dollar” is spent on goods and services. .
Formula: Velocity = Nominal GDP/Money supply
Equation of Exchange: Money Supply x Velocity = Nominal GDP (= Price Level x Real GDP) or M x V = P x Y
The quantity of the money supply affects GDP, but not directly. For example, raising the money supply would decrease velocity, canceling out the effects.
The quantity theory of money says that velocity stays constant. It rewrites our equation in the in the form of growth rates (percents of change):
%ΔM +%ΔV = %ΔP + %ΔY
Says %ΔV = 0 since it’s constant in reality, not accurate in the short run because velocity isn’t constant
Equation of Exchange is still useful, but we have to identify what causes shifts in V
Efficiency of the Payments System - with computers money moves rapidly
Interest Rates - increasing monetary supply decreases interest rates
So if M (monetary supply) is increased, V would decrease (since interest rates are part of V) - so we can’t say nominal GDP will increase if we increase the monetary supply
Monetarists believe that if we can figure out V, then we can use M to control GDP they are a competing school of thought to Keynes’ C + I + G + (Ex-Im) might work in the long run, but again, not accurate in the short run
Fiscal
Expansionary fiscal policy (more G aka govt spending) raises interest rates, and tighter fiscal policies lower interest rates
Because a rise in G causes interest rates to rise, which reduces private investment aka I, the multiplier effect is reduced (the 1/(1-MPC) formula is exaggerated)
There are stabilization lags: Fiscal affect aggregate demand through consumer spending more quickly than monetary which affects aggregate demand through investment however there are other lags related to how quickly these measures come into place - the
Ch 14: Differing Views on Fiscal and Monetary Policy
Monetary
Velocity indicates the number of times per year that an “average dollar” is spent on goods and services. .
Formula: Velocity = Nominal GDP/Money supply
Equation of Exchange: Money Supply x Velocity = Nominal GDP (= Price Level x Real GDP) or M x V = P x Y
The quantity of the money supply affects GDP, but not directly. For example, raising the money supply would decrease velocity, canceling out the effects.
The quantity theory of money says that velocity stays constant. It rewrites our equation in the in the form of growth rates (percents of change):
%ΔM +%ΔV = %ΔP + %ΔY
Says %ΔV = 0 since it’s constant in reality, not accurate in the short run because velocity isn’t constant
Equation of Exchange is still useful, but we have to identify what causes shifts in V
Efficiency of the Payments System - with computers money moves rapidly
Interest Rates - increasing monetary supply decreases interest rates
So if M (monetary supply) is increased, V would decrease (since interest rates are part of V) - so we can’t say nominal GDP will increase if we increase the monetary supply
Monetarists believe that if we can figure out V, then we can use M to control GDP they are a competing school of thought to Keynes’ C + I + G + (Ex-Im) might work in the long run, but again, not accurate in the short run
Fiscal
Expansionary fiscal policy (more G aka govt spending) raises interest rates, and tighter fiscal policies lower interest rates
Because a rise in G causes interest rates to rise, which reduces private investment aka I, the multiplier effect is reduced (the 1/(1-MPC) formula is exaggerated)
There are stabilization lags: Fiscal affect aggregate demand through consumer spending more quickly than monetary which affects aggregate demand through investment however there are other lags related to how quickly these measures come into place - the