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Chapter 22: Q.16 (page 582)

Suppose that government spending is increased at the same time that an autonomous monetary policy tightening occurs. What will happen to the position of the aggregate demand curve?

Short Answer

Expert verified

There's an query of effect on the aggregate demand wind, due to increase in the government expenditure, asaggregate demand increases as consumption expenditure rise.

Step by step solution

01

Concept 

Aggregate demand curve is a graphical representation, which states the correlation of the price of the specific commodity and the total quantity the consumers are willing to buy at a given price.

02

Explanation of Result 

Monetary policy tightening refers to the increase in real interest rates which shifts the aggegate demand curve to the left. It's being accepted by Federal Reserve to limit the spending.

Due to increase in the government expenditure, aggregate demand increases as consumption expenditure rise. Demand curve tends to shift to the right while the conntractionary monetary will force the aggreaget demand to shift left. Because any factor which shifts the IS curve also shifts the demand curve in the same direction, it reduces consumption by an increase in the real interest rates which appreciates the domestic currency of the nation and results in a fall in exports.

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Most popular questions from this chapter

What would be the effect of an increase in U.S. net exports on the aggregate demand curve? Would an increase in net exports affect the monetary policy curve? Explain.

Consider an economy described by the following:

C = \(3.25 trillion

I = \)1.3 trillion

G = \(3.5 trillion

T = \)3.0 trillion

NX = -$1.0 trillion

f = 1

mpc = 0.75

d = 0.3

x = 0.1

l = 1

r = 1

a. Derive expressions for the MP curve and the AD

curve.

b. Assume that p = 1. Calculate the real interest

rate, the equilibrium level of output, consumption,

planned investment, and net exports.

c. Suppose the Fed increases r to r = 2. Calculate the

real interest rate, the equilibrium level of output,

consumption, planned investment, and net exports

at this new level of r.

d. Considering that output, consumption, planned

investment, and net exports all decreased in part (c),

why might the Fed choose to increase r?

A measure of real interest rates can be approximatedby the Treasury Inflation-Indexed Security, or TIIS.Go to the St. Louis Federal Reserve FRED database,and find data on the five-year TIIS (FII5) and the personal consumption expenditure price index

(PCECTPI), a measure of the price index. Choose“Quarterly” for the frequency setting of the TIIS,and download both data series. Convert the priceindex data to annualized inflation rates by taking thequarter-to-quarter percent change in the price indexand multiplying it by 4. Be sure to multiply by 100so that your results are percentages.

a. Calculate the average inflation rate andthe average real interest rate over the most

recent four quarters of data available and the four quarters prior to that.

b. Calculate the change in the average inflation rate between the most recent annual

period and the year prior. Then calculate the change in the average real interest rate

over the same period.

c. Using your answers to part (b), compute the ratio of the change in the average real interest

rate to the change in the average inflation rate. What does this ratio represent? Comment on

how it relates to the Taylor principle

A measure of real interest rates can be approximated by the Treasury Inflation-Indexed Security, or TIIS. Go to the St. Louis Federal Reserve FRED database, and find data on the five-year TIIS (FII5) and the personal consumption expenditure price index

(PCECTPI), a measure of the price index. Choose “Quarterly” for the frequency setting for the TIIS, and choose “Percent Change From Year Ago” for the unitssetting on (PCECTPI). Plot both series on the samegraph, using data from 2007through the most currentdata available. Use the graph to identify periods of autonomous monetary policy changes. Briefly explain your reasoning.

If net exports were not sensitive to changes in the real interest rate, would monetary policy be more or less effective in changing output?
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