FED buys bonds from the publicDraw graph showing effect on interest rate. What happens to value of $ in foreign exchange

market?

MoneyMarket

Sm1 Sm2

Dm

Q

i

Q1 Q2

i1

i2

Draw graph showing effect on the interest rate from increased

saving in the U.S. What happens to nation’s capital stock?

LoanableFundsMarket

DLF

Q

i

Q1 Q2

i1

i2

SLF1

SLF2

Effect on P and GDP when $ depreciates

AD/ASAS

AD1

GDP

P

Q2Qf

P2

P1

ASLR

AD2

FED sells bonds. Draw graph showing effect on interest rate.

What happens to the value of the $ in the foreign exchange

market?

MoneyMarket

Sm1Sm2

Dm

Q

i

Q1Q2

i1

i2

Government & FED do nothing in response to short-run recession

AD/AS

AD

GDP

P

Q1 Qf

P2

P1

ASLR

ASSR1

ASSR2

Effect on interest rate when government runs a budget deficit

LoanableFundsMarket

SLF

DLF2

Q

i

Q1 Q2

i1

i2

DLF1

Value of U.S. $ and Japanese yen when U.S. interest rates increase. What happens to

American imports and exports?

Foreign Exchange Market

DYen

Q

P ($)

Q1 Q2

P1

P2

SYen1

SYen2

YenQQ2Q1

P2

P1

P (Yen)

D$1

D$2

S$

Dollars

Effect on P, GDP when $ appreciates

AD/ASAS

AD1

GDP

P

Q2Qf

P2

P1

ASLR

AD2

Effect on AD of FED’s bond sales during inflation

AD/ASAS

AD1

GDP

P

Q1Qf

P2

P1

ASLR

AD2

Government and FED do nothing in response to short-run inflation

AD/AS

AD

GDP

P

Q1Qf

P2

P1

ASLRASSR1

ASSR2

Effect on AS and SRPC when price of oil increases dramatically

Inflationrate

Unemployment rate

SRPC1

SRPC2

AD

AS1

AS2P

GDP

P2

P1

GDP2 GDP1

P goes upUnemployment rises

Expansionary fiscal policy during a recession

AD/ASAS

AD1GDP

P

Q1 Qf

P2

P1

ASLR

AD2

Effect on ASLR and LRPC when U.S. capital stock increases

Effect on ASP

GDP

Inflation

Unem.

ASLR1 ASLR2

Qf1 Qf2 NRU1NRU2

LRPC1LRPC2

The FED and Monetary policy• Always affects the money market

• Money market has vertical supply curve

• Increase in money supply lowers interest rates – increases investment and consumption and AD

• Lower interest rates cause $ to depreciate – exports increase, imports decrease

• Decrease in money supply has opposite effect

Loanable funds market

• S affected by savings; D affected by increased budget deficit (increasing G or decreasing taxes)

• Upward sloping S curve

• Increase in budget deficit raises interest rates (decreases I and C – crowding out)

• Increase in savings lowers interest rates

• Changes in income affect BOTH savings and consumption in the same direction

Short run vs. long run• If unemployment rises in the short run,

wages fall

• Falling wages increases AS (shifts to right)

• If unemployment falls in the short run, wages rise

• Rising wages decreases AS (shifts to left)

• Long run equilibrium is at the NRU

Capital Flows• Money coming into a country increases D for

that currency and increases S of other currency• Increasing D for a currency causes it to

appreciate; increasing S for a currency causes it to depreciate

• Higher interest rates in a country increases D for its currency b/c it increases the D for that country’s financial assets

• A higher P in a country decreases D for its currency b/c people will buy another country’s goods instead