ECON 1113 1st Edition Lecture 23 Outline of Last Lecture I. Monetary Policies to Combat UnemploymentII. Monetary Policies to Combat InflationIII. The Government Budget DeficitOutline of Current Lecture I. The Government Budget Deficit (continued)A. The Short Run EffectsB. The Long Run EffectsII. Keynesian versus MonetaristCurrent LectureI. The Government Budget Deficit (continued)A. Review1. Government spending (G) > taxation (T): budget deficit2. Financed by the Treasury (not the Fed) by selling, or supplying, Treasury Bonds in the Open MarketB. The Short Run Effects1. Suppose G increases from G0 to G1 or delta G, so that now, G >T, creating a deficit of ~$1trillion2. The Treasury finances the deficit by selling bonds in the Open Market3. Fiscal policy is not as powerful as the basic Keynesian model4. The reduction in investment (- delta I) caused by a deficit-financed increase in G (delta G) is called “crowding out”5. Bond Marketa. Horizontal axis: quantity of bonds/timeb. Vertical axis: price of bonds in dollars/bondc. Demand curve and supply curve presentd. Equilibrium of the two curves gives original bond price, which alsoimplies an interest ratee. Due to the Treasury selling bonds, the supply curve moves to the right, lowering bond prices, which subsequently affects interest rates6. Money Marketa. Horizontal axis: quantity of money/timeb. Vertical axis: interest rate in percentThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.c. Money demand curve and vertical money supply curve presentd. Equilibrium of the two curves gives original interest rate, which also implies a bond pricee. Due to the Treasury selling bonds, the money demand curve moves to the right, raising interest rates, which subsequently affects bond pricesf. The money supply curve is controlled by the Fed, not the Treasury7. Investment Marketa. Horizontal axis: investment spending in dollarsb. Vertical axis: interest rate in percentc. Marginal efficiency of investment curve present as dependent upon the interest rate equilibrium of the money market diagramd. When the interest rates increase, this lowers investment spending (I) by change of – delta I8. Domestic Income or Producta. Horizontal axis: nominal GDP in dollarsb. Vertical axis: planned total expenditure in dollarsc. Keynesian aggregate supply 45 degree curve from origin and total expenditure curve presentd. Equilibrium of the two curves gives the equilibrium of nominal GDPe. Delta G causes the total expenditure curve to increase by that amount initially; however, the negative delta I value lowers the TE level toward the original TE curvef. The same pattern applies to the Y values along the horizontal axis9. Conclusionsa. Increases in G (fiscal expansion policies that are finance by Treasury borrowing do not stimulate (increase Y) as much as the simple Keynesian model would suggestb. Deficit-financed increases in G lead to changes in the composition of total spending in the economy with more G and less private IC. The Long Run Effects1. Deficit-induced “crowding out” of private I results in fewer capital goods being produced over time and fewer capital goods, ceteris paribus, leads to slower economic growtha. Production Possibilities Analysis Diagrama. Horizontal axis: consumer goods (C)b. Vertical axis: capital goods (K)c. The production possibilities curve is a negative, concave upline connecting the horizontal and vertical axesd. Without a budget deficit, the point of production at full employment on the curve will exemplify the production of more capital goods than with a budget deficite. Over time a PPC with a budget deficit in place will grow less quickly than a situation without such a deficit2. Deficits reduce the efficiency of the economy overtime by transferring resources from the private sector to the government, or public sectora. Public sector decision makers have weaker incentives to maximize outputs and/or minimize costs than their private sector counterpartsb. In the private sector, higher outputs and lower costs result in bigger profits, which the decision makers get to keepc. In the public sector, such efficiencies are not as directly rewardedd. Examplea. Output target: “educate” 500 student/semesterb. Department of Economics: budgeted at $100,000c. Change target output to 600 without changing budget – noincentived. In the private sector, instructor gains a raisee. Milton Friedman: “People do not spend other people’s money as carefully as they spend their own.”II. Keynesian versus