Stocks vs. flows

1
Ch. 20 GDP and Price Indices

• Stocks vs. flows
• Final capital Initial capital Net investment
• Net Investment Gross Investment Depreciation
• Gross domestic product (GDP) is the value of all
  final goods and services (GS) produced in the
  economy during a particular time period.

2
Value Added andFinal Expenditure
Value added
Farmer
Intermediate expenditure
Miller
Final expenditure
Baker
Grocer
Consumer
3
Expenditure Equals Income

• Thus, aggregate income equals aggregate
  expenditure
• YAE or Y C I G N

4
The CPI (Simplified)
Base-period Base period Current
period basket Price Expenditure
Price Expenditure

• 5 kilograms of oranges
• 6 haircuts
• 100 bus rides
• Total expenditure

5
The GDP Deflator

• Nominal GDP value of GS produced at current
  years prices.
• Real GDP value of GS evaluated at base year
  (currently 1992) prices.
• To remove price balloon, we deflate nominal GDP
  to get real GDP by using the GDP deflator.
• The GDP deflator measures the average level of
  prices of GS included in GDP.

6
Nominal GDP, Real GDP and the GDP Deflator
(Simplified)
Current-year Current-period values
Base-period values output Price
Expenditure Price Expenditure

• 4,240 kilograms of oranges
• 5 computers
• 1,060 metres of red tape

7
Ch. 21 Measuring Unemployment
8
The Unemployment Rate

• The labour force (LF) is the sum of the employed
  (E) and the unemployed (U)
• LFEU
• The unemployment rate (u) is of the people in
  LF who are unemployed

9
The Involuntary Part-Time Rate
10
The Labour Force Participation Rate

• Discouraged workers those who are available and
  willing to work but made no efforts to find a job
  within the previous 4 weeks.
• They are not counted in LF.

11
The Employment-to-Population Ratio
12
Natural Rate of Unemployment

• There is always some unemployment.
• Full employment (FE) exists when the unemployment
  rate equals the natural rate of unemployment
  (UN).
• The natural rate of employment (UN) is the
  unemployment rate minus cyclical unemployment,
  I.e. it is the sum of frictional, structural and
  seasonal unemployment.

13
Ch. 22 AS and AD

• Potential GDP (Ypot) real GDP supplied at FE.
• Ypot depends only on economic fundamentals, i.e.
  on FEL, K and T Ypot F(FEL, K, T)
• At FE Y Ypot ? in the LR Y Ypot.
• Long-run aggregate supply (LAS) the
  relationship between real GDP supplied (Y) and
  the price level (P) in the LR.

14
The LAS Curve
140
130
120
Price level (GDP deflator, 1992 100)
110
100
90
0
700
750
800
850
900
950
Real GDP (billions of 1992 dollars)
15
The Short-Run AS

• Short-run aggregate supply (SAS) the
  relationship between Y and P in the SR (for
  constant W and Ypot).
• The SAS curve crosses the LAS curve at Y Ypot.

16
The SAS Curve
140
130
120
Price level (GDP deflator, 1992 100)
110
100
90
0
700
750
800
850
900
950
Real GDP (billions of 1992 dollars)
17
A change in Ypot change both LAS and SAS.
LAS0
140
130
SAS0
120
Price level (GDP deflator, 1992 100)
110
100
90
0
700
800
900
Real GDP (billions of 1992 dollars)
18
3 reasons for changes in Ypot

• 1) FEL ? ? Ypot ?
• 2) K ? ? Ypot ?
• 3) T improves Ypot ?

19
A Change in W affects only SAS
LAS0
140
Rise in money wage rate
130
SAS0
120
Price level (GDP deflator, 1992 100)
110
a
100
90
0
700
800
900
Real GDP (billions of 1992 dollars)
20
Aggregate Demand

• The quantity of Real GDP demanded planned Real
  Aggregate Expenditure (Yplanned).

Yplanned Cplanned Iplanned Gplanned
Xplanned Mplanned
21
The Aggregate Demand

• Aggregate demand (AD) is the relationship between
  the real GDP demanded (Yplanned) and the price
  level (P).
• Other things being equal, the higher is P the
  smaller is Yplanned
• Wealth effect
• Substitution effects

22
The AD Curve
140
130
120
Price level (GDP deflator, 1992 100)
110
100
90
0
700
750
800
850
900
950
Real GDP (billions of 1992 dollars)
23
Changes in AD
140
130
120
Price level (GDP deflator, 1992 100)
110
100
90
AD0
700
750
800
850
900
950
Real GDP (billions of 1992 dollars)
24
AD ? if

• Fiscal policy
• G ?, T ?, TR ?
• Monetary policy
• quantity of money ?, interest rates ?

• ROW
• exchange rate ?, foreign income ?
• Expectations
• future disposable income?, future inflation ?,
  future profits?

25
AD ? if

• Fiscal policy
• G ?, T ?, TR ?
• Monetary policy
• quantity of money ?, interest rates ?

• ROW
• exchange rate ?, foreign income ?
• Expectations
• future disposable income?, future inflation ?,
  future profits?

26
Long-Run Equilibrium
140
130
120
Price level (GDP deflator, 1992 100)
110
100
90
700
750
800
850
900
950
Real GDP (billions of 1992 dollars)
27
Below Full-Employment Equilibrium
LAS
SAS0
Price level (GDP deflator, 1992 100)
AD0
0
780
800
820
Real GDP (billions of 1992 dollars)
28
Above Full-Employment Equilibrium
LAS
SAS2
Price level (GDP deflator, 1992 100)
AD2
0
780
800
820
29
Fluctuations in Real GDP
820
Potential GDP
Real GDP (billions of 1992 dollars)
800
780
0
5
1
2
3
8
4
6
7
Year
30
Ch. 23 Expenditure Multipliers

• Disposable income (YD) aggregate income (Y)
  minus net taxes (NT)
• YD Y NT
• YD is either spent on consumption or saved
• YD C S
• YD ? ? C?, S?

31
Consumption Function
45o line
500
Consumption function
400
Consumption expenditure (billions of 1992
dollars per year)
300
200
100
0
100
200
300
400
500
Disposable income (billions of 1992 dollars per
year)
32
Saving Function
100
Saving (billions of 1992 dollars per year)
0
100
300
400
500
200
Disposable income (billions of 1992 dollars per
year)
-100
33
Marginal Propensities

• YD C S ? MPC MPS 1

YD C S
Dividing both sides by DYD
34
Marginal Propensity to Consume
45o line
500
Consumption function
400
Consumption expenditure (billions of 1992
dollars per year)
300
200
100
0
100
200
300
400
500
Disposable income (billions of 1992 dollars per
year)
35
Marginal Propensity to Save
100
Saving (billions of 1992 dollars per year)
0
100
300
400
500
200
Disposable income (billions of 1992 dollars per
year)
-100
36
AEplanned and Real GDP

• Induced expenditure (N) is the sum of the
  components of AE that vary with Y.
• Cplanned and Mplanned vary withY.
• Autonomous expenditure (A) is the sum of the
  components of AE that are not influenced by Y.
• Iplanned, Gplanned and Xplanned do not vary with
  Y.

37
Aggregate Planned Expenditure
1200
1000
Aggregate planned expenditure (billions of 1992
dollars)
800
600
400
200
0
200
400
600
800
1200
1000
Real GDP (billions of 1992 dollars per year)
38
Equilibrium Expenditure
45o line
1200
AE
1000
f
d
Aggregate planned expenditure (billions of 1992
dollars)
800
b
600
400
200
200
600
800
1000
400
0
1200
Real GDP (billions of 1992 dollars per year)
39
The expenditure multiplier

• The multiplier is the amount by which a change in
  A is multiplied to determine the change in EqE
  and real GDP.

40

• When there are no income taxes and no imports
• Multiplier 1? (1- MPC)
• And since MPC MPS 1
• Multiplier 1? MPS

41
The Multiplier
45o line
1100
AE0
e
1000
Aggregate planned expenditure (billions of 1992
dollars)
d
900
c
800
b
a
700
0
700
800
900
1000
1100
Real GDP (billions of 1992 dollars)
42
The Multiplier in the LR
LAS
150
140
130
SAS0
Price level (GDP deflator)
110
a
100
90
AD0
800
900
1,000
700
Real GDP (billions of 1992 dollars)
43
Ch. 24 Fiscal Policy

• Fiscal policy is the use of the federal budget to
  achieve macroeconomic objectives such as full
  employment, sustained economic growth, and price
  level stability.

44
Budget Balance

• Budget balance Revenues Outlays
• If revenues gt outlays ? a budget surplus.
• If outlays gt revenues ? a budget deficit.
• If revenues outlays ? a balanced budget.

45
Deficit and Debt

• The govt borrows to finance its deficit.
• Government debt is the sum of past govt deficits
  minus the sum of past surpluses.
• Government debt
• all past deficits all past surpluses
• It is the total amount of govt borrowing.

46
Automatic vs. discretionary fiscal policy

• Discretionary fiscal policy is a policy action
  initiated by Parliament.
• - an increase in the income tax rate
• Automatic fiscal policy is a change in fiscal
  policy due to the state of the economy.
• - income tax rate revenues increase during an
  expansion

47
Govt Expenditures Multiplier

• The govt expenditures multiplier is the
  magnification effect of a change in discretionary
  govt expenditures on GS (G) on equilibrium
  expenditure (AE) and real GDP (Y).

48
The Government Expenditures Multiplier
A 50 billion increase in G shifts the AE curve
upward by 50 billion...
45o line
1100
AE0
1000
e
Aggregate planned expenditure (billions of 1992
dollars)
d
900
c
800
b
a
700
0
700
800
900
1000
1100
Real GDP (billions of 1992 dollars)
49
The Autonomous Tax Multiplier

• Autonomous taxes are taxes that dont vary with
  real GDP (e.g., property tax).
• The autonomous tax multiplier is the
  magnification effect of a change in autonomous
  taxes on equilibrium expenditure and real GDP.

50
The Autonomous Tax Multiplier
45o line
AE0
A 100 billion tax increase shifts the AE curve
downward by 75 billion...
1100
1000
Aggregate planned expenditure (billions of 1992
dollars)
900
800
700
0
700
800
900
1000
1100
Real GDP (billions of 1992 dollars)
51
Autonomous Transfer Payments Multiplier

• Transfer payments are like negative taxes.
• Autonomous transfer payments multiplier
  Autonomous tax multiplier 0

52
Automatic Stabilizers

• An automatic stabilizer is a mechanism that
  dampens the fluctuations in real GDP without an
  explicit policy action by the govt.
• Induced taxes (IT) and transfer payments (TP)
• Induced taxes (IT) are taxes that vary with real
  GDP.
• Imports (M)
• Automatic stabilizers decrease the multiplier.

53
IT TP decrease the govt expenditures multiplier
An increase in autonomous expenditure increases
aggregate planned expenditure...
45o line
Aggregate planned expenditure (billions of 1992
dollars)
1,100
1,000
AE0
900
800
a
0
800
900
1,000
1,100
Real GDP (billions of 1992 dollars)
54
The Cyclically Adjusted Deficit

• The govts budget balance fluctuates with the
  business cycle.
• The structural surplus or deficit is the budget
  balance at full employment (FE) (when real GDP
  potential GDP).
• The cyclical surplus or deficit is the actual
  surplus or deficit minus the structural surplus
  or deficit. (It is purely due to the difference
  of real GDP and potential GDP.)

55
Cyclical Deficit and Cyclical Surplus
Y
200
Revenues
150
Outlays, revenues, and budget balance (billions
of 1992 dollars)
140
Outlays
600
700
800
900
1000
Real GDP (billions of 1992 dollars)
56
Structural Deficit and Structural Surplus
200
150
Outlays, revenues, and budget balance (billions
of 1992 dollars)
140
Outlays
0
600
700
800
900
1000
Real GDP (billions of 1992 dollars)
57
Fiscal Policy and AD

• Expansionary fiscal policy is an increase in G or
  a decrease in taxes.
• The distance of the AD curve shift is smaller for
  a tax cut than for a government expenditure
  increase of the same size.
• Contractionary fiscal policy is a decrease in G
  or an increase in taxes.

58
G and AD
45o line
1100
AE0
1000
Aggregate planned expenditure (billions of 1992
dollars)
900
800
a
0
800
900
1000
1100
Real GDP (billions of 1992 dollars)
59
G and AD
150
130
Price level (GDP deflator)
110
a
90
AD0
800
900
1000
1100
Real GDP (billions of 1992 dollars)
60
Taking Prices into account -in SR

• The increase in G has a smaller multiplier effect
  on real GDP when the prices change.
• The steeper the slope of the SAS curve, the
  smaller is the multiplier effect.

61
In SR the steeper SAS, the smaller is the
multiplier
150
130
126
a
Price level (GDP deflator)
110
90
AD0
800
900
1000
960
Real GDP (billions of 1992 dollars)
62
In SR the multiplier is zero
LAS
150
SAS0
130
Fiscal policy with unemployment
126
Fiscal policy with full employment
a
Price level (GDP deflator)
110
90
AD0
800
900
1000
960
Real GDP (billions of 1992 dollars)
63
Limitations of Fiscal Policy

• The use of fiscal policy is hampered by lags,
  especially by slow legislative process.
• That prevents it to be used to fight inflation.

64
Ch. 25 What Is Money?

• Money is any commodity or token that is generally
  acceptable as the means of payment.
• A means of payment is a method of settling a
  debt.
• Three other functions of money
• Medium of exchange
• Unit of account
• Store of value

65
Official Measures of Money

• M1 consists of currency held outside the banks
  plus demand deposits at chartered banks that are
  owned by individuals and businesses.
• M2 consists of M1 plus personal savings deposits
  and nonpersonal notice deposits at chartered
  banks plus all types of deposits at trust and
  mortgage companies, credit unions, caisses
  populaires, and other financial institutions.

66
Depository Institutions

• A depository institution a firm that takes
  deposits from HHs and firms and makes loans to
  other HHs and firms.
• The Bank of Canada is not a depositary
  institution.
• 3 Types of Depository Institutions
• Chartered banks
• Credit unions and caisses populaires
• Trust and mortgage loan companies

67
A Banks Balance Sheet

• A banks balance sheet lists its assets,
  liabilities, and net worth.
• Assets (A) what the bank owns.
• Liabilities (L) what the bank owes.
• Net worth (NW) the difference between assets
  and liabilities is the value of the bank to its
  stockholders
• Liabilities Net Worth Assets

68
Reserves

• A small fraction of banks assets are held as
  reserves.
• Reserves cash in a banks vault its deposits
  at the Bank of Canada.
• ? fractional reserve system

69
How banks create money

• The reserve ratio is the fraction of a banks
  total deposits that are held in reserves.
• The desired reserve ratio (DRR) is the ratio of
  reserves to deposits that banks wish to hold.
• Desired Reserves Deposits x DRR
• Excess Reserves
• Actual Reserves - Desired Reserves
• Whenever banks have excess reserves, they are
  able to create additional deposits I.e. money.

70
The Deposit Multiplier

• The deposit multiplier is the amount by which
  bank deposits increase due to an increase in bank
  reserves.

The deposit multiplier is the reciprocal of DRR
71
The Deposit Multiplier in Canada

• Not all loans made by banks return as reserves
  some are held as currency
• ? the deposit multiplier is smaller

72
The demand for money

• The quantity of money that people choose to hold
  depends on 4 main factors
• The price level (P)
• The interest rate (r)
• Real GDP (Y)
• Financial innovation

73
The Price Level (P)

• Nominal money money measured in current
  dollars.
• The quantity of nominal money demanded is
  proportional to P.
• Real money money measured in constant dollars.
  It reflects the buying power.
• The quantity of real money demanded (QdM) held
  does not depend on P.

74

• The Interest Rate (r)
• The opportunity cost of holding money the
  interest rate one could earn on other assets.
• r ? ? the opportunity cost of holding money ? ?
  QdM ?.
• Inflation rate ? ? interest rates ?.
• Real GDP
• Real GDP ? ? AE ? ? amount of money need to
  finance the expenditure ?.

75
Financial Innovation

• Technological change and new financial products
  change the quantity of money people wish to hold.
  
• Daily interest deposits
• Automatic transfers between demand deposits and
  savings deposits
• Automatic teller machines (ATMs)
• Credit cards and debit cards

76
The Demand for Money
6
5
Interest rate (percent per year)
4
MD
500
600
700
Real money (billions of 1992 dollars)
77
Changes in the Demand for Money
6
5
Interest rate (percent per year)
4
MD0
500
600
700
Real money (billions of 1992 dollars)
78
Interest Rate Determination

• People tend to divide their wealth between money
  and interest-bearing assets.
• The interest rate (r) is the amount paid by a
  borrower to a lender expressed as of the amount
  of the loan.
• A bond is a promise to make a sequence of future
  payments.
• There is an inverse relationship between price of
  a bond (PB) and an interest rate (r)
• PB ? ? r ?

79
One-year Bond

• When bond with a particular face value (or par
  value, or redemption value) of X is bought at a
  particular price, the interest rate is calculated
  as
• E.g. The interest rate on 1,000 bond bought at
  800 is 25.

80
One-year Debt Security

• When a debt security pays back a principal plus
  an interest payment, then the interest rate is
  calculated as
• E.g. The interest rate on a debt security with
  1,000 principal and 200 interest payment is 20.

81
Interest Rate on a Perpetuity

• A perpetuity is a bond that promises to pay a
  fixed amount of money per year forever.
• There is an inverse relationship between price of
  a bond (PB) and an interest rate (r)
• PB ? ? r ?

82
Money Market Equilibrium

• The interest rate (r) is determined by the money
  supply and money demand.
• The real money supply (MS) is fixed
• the quantity of nominal money supplied is fixed
  by the central bank
• the price level is fixed

83
Money Market Equilibrium
7
6
5
Interest rate (percent per year)
4
3
MD
500
600
700
Real money (billions of 1992 dollars)
84
Interest Rate Changes
MS0
8
MS ? ? r ?
7
6
5
Interest rate (percent per year)
4
3
2
1
MD
0
500
600
800
400
700
Real money (billions of 1992 dollars)
85
Real vs. Nominal Interest Rate
The nominal interest rate return on an asset
(a bond) expressed in terms of money. It is the
opportunity cost of holding money. The real
interest rate return on an asset expressed in
terms of what money will buy. It is the
opportunity cost of spending. The real interest
rate ? the nominal interest rate minus the
inflation rate.
86
Expenditure Plans

• Planned Consumption Expenditure (C)
• r ? ? C ?, S ? (not very large effect)
• Planned Investment Expenditure (I)
• r ? ? I ?
• Planned Net Exports Expenditure (NX)
• r ? ? the exchange rate ? ? NX ?
• The interest-sensitive expenditure curve (the IE
  curve) shows the relationship between AE plans
  and the real interest rate (everything else the
  same).

87
Interest-Sensitive Expenditure Curve
8
7
6
5
Interest rate (percent per year)
4
3
2
1
0
50
100
150
Real money (billions of 1992 dollars)
88
Interest-Sensitive Expenditure Curve
A change in the real interest rate, other things
remaining the same, brings a movement along the
IE curve
8
7
6
5
Interest rate (percent per year)
4
3
IE
2
1
0
50
100
150
Real money (billions of 1992 dollars)
89
Ch. 26 Monetary Policy

• Monetary policy is the attempt to control
  inflation and moderate the business cycle by
  changing
• the quantity of money in circulation
• the interest rates
• the exchange rate.

90
The Bank of Canada

• The Bank of Canada is Canadas central bank.
• A central bank is a public authority that
  supervises financial institutions and markets and
  conducts monetary policy
• Was independent until 1967, since than
  subordinate to govt

91
The Functions of the Bank of Canada

• To conduct monetary policy
• To act as lender of last resort
• To issue the countrys bank notes
• To act as a financial adviser and a fiscal agent
  to the federal govt
• be responsible for the govt of Canada debt
  management
• To regulate payment and settlement system

92
Bank of Canadas Balance Sheet

• Assets Liabilities
• govt of Canada Bank of Canada notes
• securities outside the Bank
• loans to chartered the deposits by
• banks chartered banks
• Govt deposits

93
The Monetary Base

• The monetary base (MB) is the sum of the Bank of
  Canada notes outside the Bank, chartered banks
  deposits at the Bank of Canada, and coins held by
  HHs, firms, and banks.

94
Monetary Policy Tools

• Four policy tools impact on bank reserves and the
  quantity of money (M)
• Required reserve ratio (RRR)
• Bank rate and bankers deposit rate
• Open market operations
• Government deposit shifting

95
A policy tool RRR

• Until 1992, the banks were required to hold a
  fixed proportion of deposits in reserves.
• Since 1992, banks in Canada have not been
  required to hold reserves RRR 0.

96
The Overnight Loans Rate

• The overnight loans rate is the interest rate on
  large-scale loans that chartered banks make to
  each other and to dealers in financial markets.
• Its not a policy tool, but a policy indicator.
• It is a main policy indicator.

97
A policy tool Interest Rates

• The bank rate is the interest rate that the Bank
  charges the chartered banks on the reserves it
  lends them.
• The bankers deposit rate is the interest rate
  that the Bank pays the chartered banks on the
  deposits at the Bank.
• It is 0.5 less than the bank rate.
• The Bank can always make the overnight loans rate
  hit its target range by its setting of the bank
  rate and the bankers deposit rate.

98
A policy toolOpen Market (OM) Operations

• An open market operation is the purchase or sale
  of govt of Canada securities Treasury bills and
  govt bonds by the Bank of Canada from or to a
  chartered bank or the public.
• Its the main tool.

99
A policy tool Govt Deposit Shifting
Govt deposit shifting is the transfer of govt
funds by the Bank from the govts account at the
Bank to or from its accounts at the chartered
banks. Its a very minor tool.
100
Controlling the Money Supply

• When the Bank of Canada buys securities in an OM
  operation ?
• ? the monetary base ? ? banks lending ? ? the
  quantity of money ?
• When the Bank of Canada sells securities in an OM
  operation ?
• ? the monetary base ? ? banks lending ? ? the
  quantity of money ?

101
Money Multiplier

• The money multiplier is the amount by which the
  quantity of money changes from a change in the
  monetary base.
• A currency drain makes it smaller.
• A currency drain occurs when people hold currency
  rather than deposit the currency in banks.

102
Money Multiplier vs. Deposit Multiplier

• The deposit multiplier is the amount by which
  bank deposits increase due to an increase in bank
  reserves.

The deposit multiplier is the reciprocal of DRR
103
Ripple Effects of Monetary Policy

• Monetary policy ripples thru the economy.
• When the Bank of Canada sells securities on the
  open market
• MB ?, M ? ?
• the interest rate ?
• the exchange rate ?

? C ?, I ?, loans ? ? NX ?
104
(No Transcript)
105
To lower unemployment, the Bank buys securities
LAS
140
130
Price level (GDP deflator, 1992100)
SAS
120
110
105
100
90
AD0
950
750
700
800
850
900
Real GDP (billions of 1992 dollars)
106
To lower inflation, the Bank sells securities
LAS
140
130
Price level (GDP deflator, 1992100)
125
SAS0
120
115
110
100
AD0
90
950
750
700
800
850
900
Real GDP (billions of 1992 dollars)
107
The Bank Targets Interest Rate
MSA
8
7
Fluctuations in the demand for money bring
fluctuations in the supply of money
6
Interest rate (percent per year)
5
4
3
MDA
0
590
600
610
Real money (billions of 1992 dollars)
108
instead of Money Supply
8
MS
7
Fluctuations in the demand for money bring
fluctuations in the interest rate
6
5
Interest rate (percent per year)
4
3
2
MDA
1
0
600
Real money (billions of 1992 dollars)
109
Ch. 27 Fiscal and Monetary Interactions

• Both Fiscal and Monetary Policies have 1st round
  and 2nd round effects.
• Two 2nd round effects simultaneously
• due to the increasing real GDP
• due to the increasing price level.

110
1st Round Effects of an Expansionary FP
SAS
Price level (GDP deflator, 1992100)
An expansionary FP (e.g.G?) increases AD...
110
AD0
800
700
900
1000
1100
Real GDP (billions of 1992 dollars)
111
2nd Round Effects of an Expansionary FP on AD
SAS
Price level (GDP deflator, 1992100)
Rise in interest rate limits effects of FP
110
AD1
AD0
800
900
1000
Real GDP (billions of 1992 dollars)
112
2nd Round Effects of an Expansionary FP on Money
Market
MS0
Interest rate (percent per year)
7
6
5
MD0
600
Real money (billions of 1992 dollars)
113
2nd Round Effects of an Expansionary FP on
Expenditure
Interest rate (percent per year)
7
6
5
IE
0
75
100
50
Interest-sensitive expenditure (billions of 1992
dollars)
114
Crowding Out

• Expansionary FP ? the interest rate ? ? all the
  interest-sensitive components of AE (IE) ?
• The decrease in investment that results from an
  expansionary FP is called crowding out.
• Crowding out may be
• Partial ?I ?G gt 0
• Complete ?I ?G 0 (no crowding in)

115
International Crowding Out

• Expansionary FP ? the interest rate ? ? the
  dollars value against other currencies ? ? NX?.
• The tendency for expansionary fiscal policy to
  decrease net exports is called international
  crowding out.

116
1st Round Effects of an Expansionary MP on Money
Market
MS0
Price level (GDP deflator, 1992100)
5
1
MD0
600
0
1050
Real money (billions of 1992 dollars)
117
1st Round Effects of an Expansionary MP on
Expenditure
Interest rate (percent per year)
the decrease in the interest rate increases IE...
5
1
IE
100
0
200
Interest-sensitive expenditure (billions of 1992
dollars)
118
1st Round Effects of an Expansionary MP on AD
SAS
Price level (GDP deflator, 1992100)
110
AD0
800
1000
Real GDP (billions of 1992 dollars)
119
2nd Round Effects of an Expansionary MP on Money
Market
MS0
MS1
6
5
4
Price level (GDP deflator, 1992100)
3
2
1
MD0
1004
600
1050
0
Real money (billions of 1992 dollars)
120
2nd Round Effects of an Expansionary MP on
Expenditure
Interest rate (percent per year)
6
5
4
3
2
1
IE
0
100
200
175
150
Interest-sensitive expenditure (billions of 1992
dollars)
121
2nd Round Effects of an Expansionary MP on AD
SAS
Price level (GDP deflator, 1992100)
Rise in interest rate limits effects of MP
110
AD1
AD0
800
1000
900
Real GDP (billions of 1992 dollars)
122
Money and the Exchange Rate

• The money supply ? ?
• the interest rate ? ?
• a depreciation of the Canadian dollar against
  other currencies ?
• NX ?, real GDP ?, the price level ?.

123
Policy Coordination

• Policy coordination occurs when the govt and the
  Bank of Canada work together to achieve a common
  set of goals.
• Effects on the interest rate
• An expansionary FP ? interest rate ?
• An expansionary MP ? interest rate ?
• Effects on the exchange rate
• An expansionary FP ? exchange rate ?
• An expansionary MP ? exchange rate ?

124
Policy Conflict

• Different concerns
• Govt employment and production - in SR
• Bank of Canada price level stability - in LR
• Policy conflict financing the govt debt.
• A sale of govt deficit to the Bank costs the govt
  no interest (while it must pay interest to the
  public).
• If the Bank buys the debt, this increases the
  monetary base, which leads to inflation.

125
The Great Depression

• Before 1929 a long period of prosperity.
• October 1929 the stock market collapsed.
• Next four years - economic depression.
• 20 of the work force had no jobs.
• Many families had virtually no income.

126
The Great Depression
SAS29
7.7
Price level (GDP deflator, 1992 100)
6.3
81
56
Real GDP (billions of 1992 dollars)
127
Why the Great Depression Happened?

• 1) International uncertainty
• Changing patterns of world trade Britains
  decline, Japans rise.
• International currency fluctuations and trade
  restrictions.
• 2) Domestic uncertainty when the boom will end?

128
Initial Decrease in AD

• 1) Domestic uncertainty ? slowdown in consumer
  spending.
• 2) The stock market crash ? investment collapsed
  the building industry almost disappeared.

129
Further Decrease in AD

• 1. The money supply was cut severely.
• In the United States, the money supply fell by
  20, due to bank failures.
• In Canada, the money supply contracted by 5
  annually.
• 2. Central banks tried to increase their gold
  reserves, transmitting the problem
  internationally.

130
Can It Happen Again?

• The Great Depression is less likely today because
  of
• Bank deposit insurance
• The Bank of Canadas role as lender of last
  resort
• Taxes and government spending
• Multi-income families