Expectations, Output, and Policy Chapter 17

© 2013 Pearson Education, Inc. All rights reserved Expectations and Decisions: Taking Stock Figure 17-1 Expectations and Spending: The Channels

© 2013 Pearson Education, Inc. All rights reserved Expectations and Decisions: Taking Stock

© 2013 Pearson Education, Inc. All rights reserved Expectations and Decisions: Taking Stock Figure 17-2 The New IS Curve A decrease in the current real interest rate, given unchanged expectations of the future real interest rate, does not have much effect on spending. A change in current income, given uchanged expectations of future income, is likely to have a small effect on spending.

© 2013 Pearson Education, Inc. All rights reserved Expectations and Decisions: Taking Stock The LM relation The decision about how much money to hold is largely myopic. How much money you want to hold depends on your current level of transactions. The opportunity cost of holding money today depends on the current nominal interest rate. Therefore, expectations do not enter into the LM relation.

© 2013 Pearson Education, Inc. All rights reserved Monetary Policy, Expectations, and Output Figure 17-3 The New IS–LM

© 2013 Pearson Education, Inc. All rights reserved Monetary Policy, Expectations, and Output

© 2013 Pearson Education, Inc. All rights reserved Monetary Policy, Expectations, and Output Figure 17-4 The Effects of an Expansionary Monetary Policy

© 2013 Pearson Education, Inc. All rights reserved Monetary Policy, Expectations, and Output Given expectations, an increase in the money supply leads to a shift in the LM curve and a movement down the steep IS curve. The result is a large decrease in r and a small increase in Y. If an increase in money leads to an increase in expected output and a decrease in the expected interest rate, the IS curve shifts to the right, leading to a lerger increase in Y.

© 2013 Pearson Education, Inc. All rights reserved Monetary Policy, Expectations, and Output The effects of monetary policy depend crucially on its effect on expectations. If a monetary expansion leads financial investors, firms, and consumers to revise their expectations of future interest rates and output, then the effects of the monetary expansion on output may be very large. If expectations remain unchanged, the effects of the monetary expansion on output will be small.

© 2013 Pearson Education, Inc. All rights reserved Deficit Reduction, Expectations, and Output Figure 17-5 The Effects of a Deficit Reduction on Current Output

© 2013 Pearson Education, Inc. All rights reserved Focus: Can a Budget Deficit Reduction Lead to an Output Expansion? Ireland in the 1980s Table 1 Fiscal and Other Macroeconomic Indicators, Ireland, 1981 to 1984, and 1986 to 1989