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comprises any means by which public agents affect the economy directly (e.g., by government spending) or indirectly, through incentives affecting private agents’ behavior (e.g., interest rates, taxes, if public agents like government get involved in the economy, they perform economic policy
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In the short run public agents use two types of tools: fiscal and monetary policy start learning
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includes changes in government spending, taxes and transfers
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start learning
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includes changes in money supply which affect the market interest rate
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Depending on its goal economic policy can be expansionary or restricitve start learning
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when its aimed at raising ou t put and income
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restrictive (contractionary) Depending on its goal economic policy can be expansionary or restricitve start learning
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when the aim is reducing output and income
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Fiscal expansion includes Fiscal expansionary policy start learning
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- higher transfers and/or government expenditure -lower taxes
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fiscal expansionary policy in other words start learning
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Monetary expansion (easing) start learning
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means increasing the money supply by the central bank through 1. buying financial assets in the open market 2. lowering the discount rate (the policy rate, 3. lowering the reserve rate and thus lowering the market interest rate and increasing autonomous expenditure
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the transmission mechanism of monetary policy money supply is the main tool of monetary policy start learning
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M -> i up, C, I, NX down -> Z down -> Y down actions in the money market which translates into the goods market
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describes the extent to which the goal is realized The goal of fiscal expansion is to increase output and the effectiveness will measure this goal
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is an economic theory arguing that rising public sector spending drives down or even eliminates private sector spending. G up -> Z up -> Y up -> Md up -> i up -> C, I, NX down increasy in money demand caused by bigger government spending leads to an increase in interest rates which is followed by the decrease in consumption, investment and net exports
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the stronger the crowding out effect... how it affects the fiscal expansion start learning
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the lower the efficiency of fiscal expansion
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Income elasticity of money demand start learning
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is an economic measure of how responsive the quantity demand for a good or service is to a change in income.
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the effectiveness of fiscal policy depends on which slope start learning
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Fiscal policy is more effective when LM is start learning
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flat - income elasticity of money demand (k) is small or interest rate elasticity of money demand (h) is high
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Fiscal policy is relatively effective when start learning
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• the interest rate does not rise much and/or • its rise does not have strong impact on autonomous spending
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Fiscal expansion is relatively ineffective when start learning
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1. interest rate elasticity of investment (d2) or of net exports (n) is high. 2. i ncome elasticity of money demand (k) is high, 3. interest rate elasticity of money demand (h) is small
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The effectiveness of monetary policy depends on the which slope start learning
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Monetary policy is more effective when start learning
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•𝑡𝑛 is small or •d2, n and/or 𝑐1 is high
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Monetary policy is re la tively ineffective when: start learning
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1. interest rate elasticity of autonomous expenditure is low, 2. interest rate elasticity of money demand is high 1. (lowering the interest rate by the central bank does not boost autonomous spending) 2. (even a slight decrease in the interest rates restores equilibrium in the money market)
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at very low interest rates further increases in money supply by the central bank do not encourage more economic activity •the only variable that rises is the money demand •the central bank essentially loses its control over the real economy any amount of money issued by the central bank is being held by the public in liquid form instead of financial or physical assets
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