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  =  IR N 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 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 all the prices in an economy double  Gas, TVs, cars, homes, and nominal wages  Assume 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 IR EQ

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.