Unit V:Monetary and Fiscal Policy

Combinations: Stabilization Policy in the Real World

“Lags” associated with Policy Making

Inside Lag - Time it takes for:Data to be collectedPolicy makers to recognize that policy action is necessaryDecision about which policy should be takenImplementation of the policy

Unit V Lesson 1

Outside (Impact) LagTime it takes for the economy to respond to the new policy

These lags differ in length for monetary and fiscal policy

Unit V Lesson 1

Complete Activity 43 and review answers

Unit V Lesson 1

Government in a deficitBorrows money to finance its deficitResults in an increase in the demand for money (demand for loanable funds)Results in an increase in the interest rateHigher Interest Rates cause a decrease in investment and interest sensitive components of consumer demandCrowding out – decrease in private demand for funds when the government’s demand for funds causes the interest rates to rise

Unit V Lesson 1

Explain and IllustrateVisual 5.1

Unit V Lesson 1

Loanable Funds MarketDemand for funds in this market comes from:

The private sector (business investment and consumer borrowing) The government sector (budget deficits)Foreign sector

Supply of funds in the this market comes from:

Private savings (businesses and households)The government sector (budget surpluses)The Federal Reserve (money supply)Foreign sector

Unit V Lesson 1

Explain and IllustrateVisual 5.2

Unit V Lesson 1

Indirect effect of government budget

deficits

Barro-Ricardo effectPossibility that these deficits will lead to an increase in private savings and a decrease in consumption that offsets the predicted expansionary effects of expansionary policy

Unit V Lesson 1

Complete Activity 44 and review answers

Unit V Lesson 1

Explain and IllustrateVisual 5.3; Go through

steps identified in teacher’s manual

Unit V Lesson 2

Complete Activity 45 and review answers

Unit V Lesson 2

Explain and Illustrate Visual 5.4; Go through

steps identified in teacher’s manual

Unit V Lesson 3

Complete Activity 46 and review answers

Unit V Lesson 3

Economic GrowthFor growth to occur, economic agents – producers and consumers – must have appropriate incentivesGrowth accounting focuses on three sources of long-run economic growth:

Supply of laborSupply of capital The level of technology

In the most fundamental sense, economic growth is concerned with increasing an economy’s total productive capacity

Unit V Lesson 4

How can these “levers of growth” be stimulated

Increasing savings will increase the supply of loanable funds, decrease interest rates and spur investment or increases in the capital stock

Tax incentives are the principal method to increase savings

Increasing government support for basic research will stimulate research and development

National Science Foundation grants are one mechanism used in the U.S.

Unit V Lesson 4

Getting the most from comparative advantage by encouraging international trade will also stimulate growth throughout the worldGrowth can also be stimulated by improving the quality and capabilities of the labor force so workers can be more productive with a given level of capital and technology

The U.S. has focused on improving the quality of public education and using education IRAS

Unit V Lesson 4

Complete Activity 47 and review answers

Unit V Lesson 4

More Lags Recognition lag

The time it takes for policy makers to see there is a problem with the economy (3 to 6 months)

Decision or Response lagThe time it takes policy makers to decide and implement the policy response to the current economic problemMonetary Policy decision lag – usually very short (one quarterFiscal Policy decision lag – can be several quarters to more than a year

These combined make up the Inside lag

Unit V Lesson 5

Transmission or impact lag (the outside lag) - the time it takes the change in policy to have an effect on the economy

Transmission lag for monetary policy is long and variableTransmission lag for fiscal policy is generally very short

Unit V Lesson 5

Reasons why prices and wages do not adjust

quicklyMenu costs

It costs firms money to change their prices – for example, to issue new catalogs or change price tags

Labor contractsMultiyear contracts prohibit changes in wages and may mandate COLA’s

Firms operating in imperfectly competitive markets worry about changing prices and getting into price wars with their competitors

Thus firms may be slow to adjust prices to changes in costs or demand

Unit V Lesson 5

REVIEW FOR UNIT V EXAM