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Chapter 12. Aggregate Demand II
The appendix is interesting, but will not be covered.
Homework: p. 352-54 # 1, 2, 5, 7a or b
is_lm_model #1, 3, 7
Link to syllabus
Janet Yellen
Born in 1946.
B.A. (economics) from Brown. Ph.D. from Yale.
Currently Vice-Chair of the Fed.
Recently was President of the San Francisco
Branch of the Fed.
Head of Clinton’s Council of Economic Advisors
Professor at UC-Berkeley
Considered to be less concerned about inflation, and more worried
about unemployment; so she will probably follow Bernanke’s policies.
Is said to have underestimated the dangers of the housing bubble of the
late 2000s, which was a big deal in California.
Ben Bernanke nominated to head
Federal Reserve
Strengths: Top level academic, experience with Fed
and working in White House. Anti-inflation stance.
Weakness: not enough experience in banking and
private sector.
Bernanke &
Greenspan: October
25, 2005
RollerCoaster joe
GreenspanJoke
Greenspan pictures
Fan of Benny Goodman
A member of Ayn
Rand’s “collective”
Greenspan and
Paul Volcker, his
predecessor
Close, but no cigar
Greenspan
viewed by
cartoonists
Inscrutable Alan
Fig. 12-1, p. 328. An Increase in Gov’t
Purchases in IS-LM
Fig. 12-2, p. 330. A Decrease in Taxes in the ISLM Model
Fig. 12-3, p. 330. An Increase in Money in the ISLM Model
Fig. 12-4, p. 332 (Potential)
Responses of the Economy
to a Tax Increase
Table 12-1 p 334
Equations from Ray Fair’s Econometric Model
Link to RSQE Forecast
Link to Michigan Forecast
Conference
“If monetary policy is like driving a car, then the car is
one that has an unreliable speedometer, a foggy
windshield and a tendency to respond unpredictably.“
Ben Bernanke. 2002
Homework #1 page 256 (chapter 9)
1. Assume a change in government regulations allows banks to pay
interest on checking accounts.
a. How does this affect the demand for money?
It would increase the demand for money, and hence the velocity would
decline. (Assuming that the public switches from stocks and bonds to
checking accounts. It might also be argued that people would switch
from cash to checks… ultimately I see this as an empirical question.
c. If the Fed keeps the quantity of money constant, what happens?
Would increase interest rates, lowering investment, output etc.
d. Should the Fed sit tight, or respond?
My answer is that it should increase the supply of money.
Why has the Fed chosen to use an interest rate, rather than the
money supply, as its short term policy instrument? (page 290)
Shocks to the LM curve are more prevalent than shocks to
the IS curve. When the Fed targets interest rates, it automatically
offsets LM shocks that alter the money supply but the policy
exacerbates IS shocks. (Question #7 page 353.)
Review of Working with IS-LM
Certain important exogenous variables move the curves:
Government spending and taxes move the IS, M moves LM
The curves can shift because of changes in behavioral relationships:
The consumption function, investment function, money demand
One can also use the logic of the derivation of the curves, to argue
that the steeper investment demand, or money demand, the steeper
will be the IS and the LM, respectively. However, the higher the
MPC, the flatter the IS curve.
Homework page 352 #2.
#2. Use IS-LM to predict the effects of the following:
a. New computer chips, firms invest in computers
IS moves right
b. Due to fraud, people use credit cards less, and increase demand money
Increased money demand moves LM curve left
c. People decide to save more
IS moves left
Fig. 12-5, p. 338. Deriving the AD Curve with the
IS-LM Model
For a point (Y1, P1) on the AD curve, if you increase P, what has to
happen to Y to regain equilibrium? Answer, Y falls from Y1 to Y2.
(Called the real balance effect)
Fig. 12-6,
p. 339.
Recall Fig. 10-13, p. 295. An Increase in AD
Recall Fig. 10-14, p. 297. An Adverse Supply Shock.
Fig. 12-7, p. 340. The Short Run and Long Run Equilibria
First, in (b), AD falls to the level shown; economy is at K. As prices
(and wages) fall, the economy goes from point K to point C.
This line should not be labeled LRAS,
because you shouldn’t have AS on IS-LM.
But it is appropriate to indicate somehow the
full employment level of income.
Table 12-2 (a), p. 342
Table 12-2 (b), p. 343
Fig. 12-8, p. 347. Expected Deflation in the
IS-LM Model
Inflationary Expectations—ISR at UM-AA