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The Marriage of Fiscal & Monetary Policy AP Macroeconomics http://www.glennbeck.com/content/blog/stu/marriage-equality-for-al/ Where did we come from? We discussed the market for loanable funds, as well as the Barro-Ricardo effect. What is the BarroRicardo effect? 19th Century economist, David Ricardo, after whom the Barro-Ricardo effect is named. http://en.wikipedia.org/wiki/Political_economy The Barro-Ricardo Effect An indirect effect of government budget deficits is the possibility that these deficits will lead to an increase in private savings and a decrease in consumption that offset the predicted expansionary fiscal policy. Why would this happen? Because people expect that when the government runs a deficit [the government takes in less than it puts out] it will increase taxes in order to repay the money being borrowed. Thus, people (possibly) save and consume less. This is called the Barro-Ricardo effect. Where are we going? This lesson continues to examine the interaction between monetary & fiscal policy, and the impact of monetary policy on the following: Price level Output Unemployment Interest rates Investment http://www.ronedmondson.com/2009/05/his-footprints-in-the-sand.html The Effects of Policy Changes in Multiple Markets Let’s say that, in response to the current economic situation, the government decides to increase its spending without increasing taxes and the Fed keeps the MS constant (w/no Barro-Ricardo effect). What would happen? •AD shifts to the right •Increased demand for loanable funds •MD also shifts to the right So what about…? Output Employment Price level Interest rates Investment So what about…? Output (real GDP): increased. AD increased because of the increase in government spending. Employment: increased. AD increased because of the increase in government spending. Price level: increased. “ “ Interest rates: increased. With the MS held constant, the demand for loanable funds increased, along with the interest rate. Investment: decreased because of the increase in the interest rate. What about crowding-out? What could the Fed have done to prevent crowding out? Are there certain conditions when the Fed should or should not prevent crowding-out? And now… Some resources: Reffonomics: http://www.reffonomics.com/ Morton workbook: Activity 45 Works Cited Economics of Seinfeld. http://yadayadayadaecon.com/ Krugman, Paul, and Robin Wells. Krugman’s Economics for AP. New York: Worth Publishers. Morton, John S. and Rae Jean B. Goodman. Advanced Placement Economics: Teacher Resource Manual. 3rd ed. New York: National Council on Economic Education, 2003. Print. Reffonomics. www.reffonomics.com.