Deck 25: An Aggregate Supply and Demand Perspective on Money and Economic Stability

Question 1

How does the slope of the aggregate supply curve help determine whether GDP will be stable at full employment

Answer 1

Aggregate supply curve affects money and the economy in the following way:
The slope of the curve of aggregate supply is vertical in the long-run. But in the short-run, aggregate supply curve can be upward. When the slope of a curve of aggregate supply is upward then the GDP will be stable at full employment.
First, the employment will decline because of reduction in output. Wages will decrease, and thus companies will have to increase employment in order to achieve full output.
If an aggregate supply curve is positively sloped then inflation will occur causing an increase in income and a decline in unemployment. This will cause the GDP to be stable under the full employment.

Question 2

What is the Phillips curve, and how is it related to the aggregate supply curve

Answer 2

Phillips curve shows a relationship between unemployment and inflation. It proposes that if the public was willing to have higher inflation than unemployment would be reduced.
Aggregate supply curve is related to the Phillips curve in that it shows a higher inflation causing higher income and lower unemployment. The unemployment is so low, that it can be viewed as full employment, just like Phillips curve suggests.

Question 3

Does an increase in money supply increase interest rates or decrease interest rates ( Hint: Be careful to identify real versus nominal interest rates.)

Answer 3

An increase in money supply will cause the market to expect an inflation, which in turn will raise nominal interest rates.
If the public expects an increase in money supply by policymakers, then the real interest rate will not change at the time of an actual increase. The decrease in real interest will occur before money supply is increased.

Question 4

What is meant by crowding out How many different types of crowding out can you identify

Question 5

Why should the money supply grow in the long run

Question 6

Discussion question: Do you believe we would be better off with a monetary policy that follows a fixed rule for money supply growth Explain why we do not (and are not likely to) have one.