Transcript Rec. GAP
Policy in on open economy The three major graphs for fiscal or monetary policy are: 1. AD/AS 2. The domestic money market 3. The international money market P AS ☺ F.E. AD= C+I+G+NX RGDP loanable funds r (federal funds rate) S r* D $Q* Quantity ($ millions) Equilibrium Exchange Rate Price of $ S P* D Q* Quantity How does the presence of the international sector affect the use of fiscal and monetary policy? P AS AD= C+I+G+NX RGDPC F.E. Rec. GAP RGDP To solve the Rec. Gap with fiscal policy, we need to increase government spending or cut taxes to stimulate consumption to increase AD to AD’. P AS RGDPC AD’ AD= C+I+G+NX F.E. RGDP Rec. GAP When AD increases, consumers buy more goods at higher prices so the demand for money increases which causes interest rates to increase loanable funds r (federal funds rate) S r1 r* D’ D $Q* Quantity ($ millions) This increase in interest rates causes the demand for the dollar on the international market to go up, and the supply to go down. Thus, the dollar appreciates in value Price of $ S’ S D’ D P* P Q Quantity The stronger dollar causes our imports to increase and our exports to fall, so NX decreases which lowers AD’ to AD”. P AS AD” RGDPC AD’ AD= C+I+G+NX F.E. RGDP Rec. GAP Fiscal policy is weakened by the presence of the international sector with floating exchange rates. The more integrated an economy is with the world market, the less effective fiscal policy will become. P AS AD F.E. RGDPC Infl. GAP RGDP To solve the Infl. Gap with fiscal policy, we need to decrease government spending or increase taxes to cut consumption to decrease AD to AD’. P AS AD=C+I+G+NX AD’ F.E. RGDPC Infl. GAP RGDP When AD decreases, consumers buy fewer goods at lower prices so the demand for money decreases which causes interest rates to decrease loanable funds r (federal funds rate) S r0 r1 D D’ $Q* Quantity ($ millions) This decrease in interest rates causes the demand for the dollar on the international market to go down, and the supply to go up. Thus, the dollar depreciates in value Price of $ S S’ D D’ P0 P1 Q Quantity The weaker dollar causes our imports to decrease and our exports to increase, so NX increases which increases AD’ to AD”. P AS AD” AD=C+I+G+NX AD’ F.E. RGDPC Infl. GAP RGDP P AS AD= C+I+G+NX RGDPC F.E. Rec. GAP RGDP To solve the Rec. Gap with monetary policy, the fed needs to buy government bonds to increase loanable funds to increase the money supply to lower interest rates which increases investment and AD loanable funds r (federal funds rate) S S’ r0 r1 D $Q* Quantity ($ millions) P AS RGDPC AD’ AD= C+I+G+NX F.E. RGDP Rec. GAP When AD increases, consumers buy more goods at higher prices so the demand for money increases which causes interest rates to increase loanable funds r (federal funds rate) S S’ r0 r2 r1 D’ D $Q* Quantity ($ millions) interest rates on net fall which causes the demand for the dollar on the international market to fall, and the supply to increase. Thus, the dollar depreciates in value Price of $ S S’ D D’ P* P Q Quantity The weaker dollar causes our imports to decrease and our exports to increase, so NX increases which increases AD’ to AD”. P AS AD” RGDPC AD’ AD= C+I+G+NX F.E. RGDP Rec. GAP Monetary policy is strengthened by the presence of the international sector with floating exchange rates. The more integrated an economy is with the world market, the more effective monetary policy will become. P AS AD F.E. RGDPC Infl. GAP RGDP To solve the Infl. Gap with monetary policy, the fed needs to sell government bonds to lower loans and the money supply to raise interest rates to lower investment spending and decrease AD to AD’. loanable funds r (federal funds rate) S’ S r1 r0 D’ $Q* Quantity ($ millions) P AS AD=C+I+G+NX AD’ F.E. RGDPC Infl. GAP RGDP When AD decreases, consumers buy fewer goods at lower prices so the demand for money decreases which causes interest rates to decrease loanable funds r (federal funds rate) S’ S r1 r2 r0 D D’ $Q* Quantity ($ millions) interest rates on net increase which causes the demand for the dollar on the international market to go up, and the supply to go down. Thus, the dollar appreciates in value Price of $ S’ S D’ D P1 P0 Q Quantity The stronger dollar causes our imports to increase and our exports to decrease, so NX decreases which decreases AD’ to AD”. P AS AD” AD=C+I+G+NX AD’ F.E. RGDPC Infl. GAP RGDP Because policy makers know that the AD” is coming they will do less monetary policy and more fiscal policy going from AD to AD’