HW: Krugman’s
Module 30-32
Notes Quiz
Tomorrow!!
Money Neutrality
Students will explicitly assess fiscal
and monetary policy to draw
conclusions about the different
effects of government action on
the economy.
FRQ HW Answers:
1.
a. 10%
b. i. $100 (loans  $900)
ii. $76,000
iii. M1 does not change
iv. $500
v. $81,000
c. MD =  IRN
i. P 
ii. AD
iii. N unchanged
iv. R
d. No change
2.
a. LFD  because gov’t
needs to borrow to
spend. Real interest
rates increase.
b. Investment
(private)will decrease
due to higher cost of
borrowing
c. Output decreases (I
component of GDP)
i. N unchanged
ii. R 
d.  to move back to
initial EQ level
Macroeconomic Challenge
Red vs. Black
 You
have 5 minutes to solve your
problem!
 3 Minutes to share with a partner of the
same color group!
 5 Minutes to teach your problem to a
partner of the other color group!
 Reference
any materials you need in
order to solve…
Challenge Debrief:
 What
are problems that you noticed from
any fiscal policy implementation?
Challenge Debrief
Budget deficits!
RED/Expansionary: Falling tax revenue and rising transfer payments
push the budget toward deficit
How would we balance this deficit?
We would need to increase taxes or decrease government
spending.
How would that impact the recession? It would worsen it!
BLACK/Contractionary: Rising tax revenue and falling transfer
payments push the budget toward surplus
How would we balance this surplus?
We would need to decrease taxes or increase government
spending.
How would this impact the inflationary period? It would worsen
it.
Deficits create bigger problems! How to solve???
1. Crowding-out after national debt created from consistently
running deficits…
2. Paying off the debt? Cannot borrow…like getting a credit
card to pay off another credit card. NEED to increase taxes.
3. Print money??? Cause hyperinflation?
US Debt—GDP Ratio
Currently at 101% of GDP…historic high 121%...Japan currently over 200%
Money Neutrality
 What
is the impact of expansionary monetary
policy in the long run? Think money market to
AD/AS and long run correction…
• Price level rise!!! INFLATION!!
• Output increase in short run…falls in LR @ higher PL (SRAS)
Monetary Neutrality: a change in the money supply
has no real affects on the economy (has nominal
affects!)
• In the long run, the only impact of an increase in
the money supply is an increase in aggregate price
level by an equal percentage
• Therefore economists assert money is neutral in LR
Money Neutrality
 Suppose
 Gas,
 Assume
all the prices in an economy double
TVs, cars, homes, and nominal wages
money supply doubles at the same time
 What
difference does this make to the economy in
real terms? None.
 All
real output, real money supply, real purchasing power
are unchanged—people wouldn’t behave any differently
 If
MS increases 10% so will Aggregate PL
 All
changes in MS have the same change in magnitude
on PL
A Reminder…Long Run in Money
Market
 Model
is self-correcting and in reality it is due to
money neutrality—in LR interest rates do not change
•
•
•
•
MS(10%)=SR IR
In LR PL(10%)
PL(10%)=MD(10%)
Return to initial IREQ
Exit Slip:
What is the effect of the
FED buying bonds in the
long run? Use an
annotated money market
graph and an AD/AS
model to justify your
answer.