Monetary and Fisical Policy
CHAPTER 11
MONETARY AND FISCAL POLICY
Chapter Outline:
• The effects of fiscal and monetary policy on output
• Monetary policy and the transmission mechanism
• The liquidity trap
• The classical case
• The quantity theory of money
• Fiscal policy and crowding out
• Monetary accommodation
• The effects of alternative policies on the composition of output
• The U.S. economy in the 1980s and 1990s
• Anticipatory monetary policy
• The policy mix during the German re-unification
Changes from the Previous Edition:
The material in this chapter has been updated, but its format is essentially the same. More emphasis is given to the economic expansion in the U.S. in the 1990s.
Introduction to the Material:
Chapter 11 uses the IS-LM model derived in Chapter 10 to show how monetary and fiscal policies can be used to dampen economic disturbances. The economic effects of various policy mixes are highlighted in discussions of actual events: the recession and recovery in the United States in the 1980s, the U.S. recession in 1990-91, the long economic expansion thereafter, and the policies enacted by Germany during the re-unification process in 1990-92.
First, the Fed 's conduct of monetary policy is discussed, with an explanation of how open market operations can be used to change nominal money supply. The effectiveness of monetary policy in changing the amount of output demanded depends on the steepness of the LM-curve. The transmission mechanism, that is, the process by which monetary policy changes affect the economy, occurs in several steps. First, a change in money supply leads portfolio holders to make adjustments in their asset holdings. As a result, asset prices and interest rates change. The change in interest rates subsequently affects intended spending and thus national income. Table 11-1 provides a summary of this process.
Two extreme cases in the operation of monetary policy are given special attention. Monetary policy is
MONETARY AND FISCAL POLICY
Chapter Outline:
• The effects of fiscal and monetary policy on output
• Monetary policy and the transmission mechanism
• The liquidity trap
• The classical case
• The quantity theory of money
• Fiscal policy and crowding out
• Monetary accommodation
• The effects of alternative policies on the composition of output
• The U.S. economy in the 1980s and 1990s
• Anticipatory monetary policy
• The policy mix during the German re-unification
Changes from the Previous Edition:
The material in this chapter has been updated, but its format is essentially the same. More emphasis is given to the economic expansion in the U.S. in the 1990s.
Introduction to the Material:
Chapter 11 uses the IS-LM model derived in Chapter 10 to show how monetary and fiscal policies can be used to dampen economic disturbances. The economic effects of various policy mixes are highlighted in discussions of actual events: the recession and recovery in the United States in the 1980s, the U.S. recession in 1990-91, the long economic expansion thereafter, and the policies enacted by Germany during the re-unification process in 1990-92.
First, the Fed 's conduct of monetary policy is discussed, with an explanation of how open market operations can be used to change nominal money supply. The effectiveness of monetary policy in changing the amount of output demanded depends on the steepness of the LM-curve. The transmission mechanism, that is, the process by which monetary policy changes affect the economy, occurs in several steps. First, a change in money supply leads portfolio holders to make adjustments in their asset holdings. As a result, asset prices and interest rates change. The change in interest rates subsequently affects intended spending and thus national income. Table 11-1 provides a summary of this process.
Two extreme cases in the operation of monetary policy are given special attention. Monetary policy is
References: Bullard, James B., “The FOMC in 1991: An Elusive Recovery,” Review, FRB of St. Louis, March/April, 1992. Business Week, “The Boom,” Special Report, February 14, 2000. Carlson, Keith M., “Federal Budget Trends and the 1981 Reagan Economic Plan,” Review, FRB of St. Louis, January, 1989. Carlson, K. and Spencer R., “Crowding Out and Its Critics,” Review, FRB of St. Louis, December, 1975. The Economist, “Productivity on Stilts,” June 10, 2000. The Economist, “The New Economy,” July 24, 1999. Gali, Jordi, “How Well Does the IS-LM Model Fit Postwar U.S. Data?” Quarterly Journal of Economics, May, 1992. Krugman, Paul, “How Fast Can the U.S. Economy Grow,” Harvard Business Review, July/August, 1997. Morgan, Donald P., “Are Bank Loans a Force in Monetary Policy?” Economic Review, FRB of Kansas City, Second Quarter, 1992. McNees, Stephen, “The 1990-91 Recession in Historical Perspective,” New England Economic Review, FRB of Boston, January/February, 1992. Tobin, James, “Voodoo Curse: Exorcising the Legacy of Reaganomics,” Harvard International Review, Summer, 1992. Uchitelle, Louis, “Productivity Gains Help Keep Economy on a Roll,” The New York Times, March 22, 1999.