Monetary and Fiscal Policy

1. Theory of liquidity preference

• Money supply
• Money demand = demand for liquidity: MD = f(r)
• Equilibrium

2. Liquidity preference, aggregate demand and monetary policy

• MD = f(r,p)
• Price rises => interest rate rises => C, I fall => AD moves NW
• Money supply shifts => interest rate changes => AD shifts

3. Fiscal policy:

• Changes in government spending and taxes
• Consumption function: C = a + MPC(Y - T)
• Multiplier effect: M = 1/(1 - MPC)
• Crowding out effect

4. Stabilization policy

• The case for: "animal spirits"
• The case against: policy lags
• Automatic stabilizers: tax system, unemployment insurance