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The Influence of Monetary and Fiscal Policy on Aggregate Demand How Monetary Policy influences Aggregate Demand How Fiscal Policy influences Aggregate Demand Using Policy to stabilize the Economy CHANGES in The aggregatedemand curve is downward sloping for reasons Liquidity preference: - Interest Rate - Money Supply - Money Demand Changes in Money Supply The role of Interest rate Targets in Fed Policy Governement Purchases effects cause size of the shift in AD curve Federal Funds Rate: short-term Wealth effect Interest Rate effect Exchange Rate effect Money Supply Money Demand Equilibrium in the Money Market Multiplier effect Because the Fed can control the size of the money supply directly, the quantity of money supplied does not depend on any other economic variables, including the interest rate Thus, the supply of money is represented by a vertical supply curve The Interest Rate rises, the quantity of money demanded will fall => the demand for money will be downward sloping Taxes The Interest Rate adjusts to bring money supply and money demand into balance The additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending If the interest rate > the equilibrium interest rate, the quantity of money that people want to hold < the quantity that the Fed has supplied => This surplus of money put downward pressure on the Interest Rates Monetary injection by the Fed increases the money supply, leading to a lower interest rate, and a larger quantity of goods and services demanded Crowding-out effect 1/(1-MPC) The offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending MD increase => I.R increase => I decrease => AD decrease Government cuts Personal Income Tax => Changes in taxes affect a household’s take-home pay Automatic stabilizers: changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession but that occur without policymakers having to take any deliberate action