Chapter 12. Aggregate Demand II The appendix is interesting, but will not be covered. Homework: p # 1, 2, 5, 7a or b is_lm_model #1, 3, 7 Link to syllabussyllabus

Janet Yellen Born in B.A. (economics) from Brown. Ph.D. from Yale. Currently Vice-Chair of the Fed. Recently was President of the San Francisco Branch of the Fed. Head of Clinton’s Council of Economic Advisors Professor at UC-Berkeley Considered to be less concerned about inflation, and more worried about unemployment; so she will probably follow Bernanke’s policies. Is said to have underestimated the dangers of the housing bubble of the late 2000s, which was a big deal in California.

Ben Bernanke nominated to head Federal Reserve Strengths: Top level academic, experience with Fed and working in White House. Anti-inflation stance. Weakness: not enough experience in banking and private sector.

Bernanke & Greenspan: October 25, 2005

RollerCoaster joe

GreenspanJoke

Greenspan pictures Fan of Benny Goodman A member of Ayn Rand’s “collective”

Greenspan and Paul Volcker, his predecessor Close, but no cigar

Greenspan viewed by cartoonists Inscrutable Alan

Fig. 12-1, p An Increase in Gov’t Purchases in IS-LM

Fig. 12-2, p A Decrease in Taxes in the IS- LM Model

Fig. 12-3, p An Increase in Money in the IS- LM Model

Fig. 12-4, p. 332 (Potential) Responses of the Economy to a Tax Increase

Table 12-1 p 334

Equations from Ray Fair’s Econometric Model

Link to RSQE Forecast Conference Link to Michigan Forecast

“If monetary policy is like driving a car, then the car is one that has an unreliable speedometer, a foggy windshield and a tendency to respond unpredictably.“ Ben Bernanke. 2002

Homework #1 page 256 (chapter 9) 1.Assume a change in government regulations allows banks to pay interest on checking accounts. a. How does this affect the demand for money? It would increase the demand for money, and hence the velocity would decline. (Assuming that the public switches from stocks and bonds to checking accounts. It might also be argued that people would switch from cash to checks… ultimately I see this as an empirical question. c. If the Fed keeps the quantity of money constant, what happens? Would increase interest rates, lowering investment, output etc. d. Should the Fed sit tight, or respond? My answer is that it should increase the supply of money.

Why has the Fed chosen to use an interest rate, rather than the money supply, as its short term policy instrument? (page 290) Shocks to the LM curve are more prevalent than shocks to the IS curve. When the Fed targets interest rates, it automatically offsets LM shocks that alter the money supply but the policy exacerbates IS shocks. (Question #7 page 353.)

Review of Working with IS-LM Certain important exogenous variables move the curves: Government spending and taxes move the IS, M moves LM The curves can shift because of changes in behavioral relationships: The consumption function, investment function, money demand One can also use the logic of the derivation of the curves, to argue that the steeper investment demand, or money demand, the steeper will be the IS and the LM, respectively. However, the higher the MPC, the flatter the IS curve.

Homework page 352 #2. #2. Use IS-LM to predict the effects of the following: a. New computer chips, firms invest in computers IS moves right b. Due to fraud, people use credit cards less, and increase demand money Increased money demand moves LM curve left c. People decide to save more IS moves left

Fig. 12-5, p Deriving the AD Curve with the IS-LM Model For a point (Y 1, P 1 ) on the AD curve, if you increase P, what has to happen to Y to regain equilibrium? Answer, Y falls from Y1 to Y2. (Called the real balance effect)

Fig. 12-6, p. 339.

Recall Fig , p An Increase in AD

Recall Fig , p An Adverse Supply Shock.

Fig. 12-7, p The Short Run and Long Run Equilibria This line should not be labeled LRAS, because you shouldn’t have AS on IS-LM. But it is appropriate to indicate somehow the full employment level of income. First, in (b), AD falls to the level shown; economy is at K. As prices (and wages) fall, the economy goes from point K to point C.

Table 12-2 (a), p. 342

Table 12-2 (b), p. 343

Fig. 12-8, p Expected Deflation in the IS-LM Model

Inflationary Expectations—ISR at UM-AA