Chapter 35

Chapter 35 explains the tradeoff relationship between unemployment and inflation in the short run. Phillips was the British economist that concluded that inflation and unemployment were linked. The Phillips Curve shows a negative relationship between unemployment and inflation. In the short run, a higher unemployment rate has a lower inflation rate. The Phillips curve basically demonstrates the combinations of inflation and unemployment that arise in the short run as shifts in the aggregate demand curve move the economy along the short run aggregate supply curve. In the long run, the Phillips Curve is vertical, showing that the natural rate of unemployment is unchanged by different inflation rate levels. The vertical long run Phillips curve shows the classical idea of monetary neutrality. An increase in the money supply increases aggregate demand, raises the price level, and increases the inflation rate, but leaving output and unemployment at their natural rates. Friedman and Phelps introduced a new variable to the inflation-unemployment relationship: expected inflation. Expected inflation measures how much people expect the overall price level to change. Freidman and Phelps' work can be summarized into the equation: Unemployment rate= natural rate of unemployment-a(actual inflation-expected inflation). The natural rate hypothesis is that unemployment eventually returns to its natural rate, regardless of the rate of inflation. Stagflation is the combination of rising prices and falling output. The short-run Phillips Curve shifts due to supply shocks to aggregate supply. An adverse shift in aggregate supply lowers output and raises the price level. This gives policymakers a less favorable tradeoff between unemployment and inflation. Contradictory policy moves the economy down along the short run Phillips curve but in the long run expected inflation falls and the short run Phillips curve shifts to the left. The Volcker Disinflation shows how Volcker was successful at reducing inflation, but at a cost of having a high unemployment rate.

Chapter 34

Chapter 34 is about monetary and fiscal policy and their effects on the aggregate demand curve. Out of the three reasons that the aggregate demand is downward sloping, the interest-rate effect is the most important reason. The interest rate effect, as explained in the previous chapter, is that a lower price level reduces the amount of money people want to hold. The theory of liquidity preference is that the interest rate adjusts to the money supply and money demand's equilibrium. The two pieces of the theory of liquidity preference is money supply and money demand. Money supply is controlled by the Federal Reserve, who then alters the supply with the buying and selling of government bonds in open market operations. When the Fed increases the money supply, it lowers the interest rate and increases the quantity of goods and services demanded for any price level, shifting the aggregate demand curve right. The inverse situation of this is also true. Fiscal policy is the determining of the level of government spending and taxation by policymakers. The multiplier effect is the additional shifts in aggregate demand that result when expansionary fiscal policy increases income, which then increases consumer spending. The marginal propensity to consume (MPC) is the fraction of extra income that a household consumes rather than saves. The Multiplier equation is Multiplier=1+MPC+MPC^2+MPC^3... When x=MPC then the equation can be simplified to Multiplier= 1/(1-MPC). The larger the MPC, the greater effect on consumption, and the larger the multiplier. The crowding out effect is when expansionary fiscal policy raises the interest rate, which then reduces investment spending, creating a reduction in aggregate demand. Economic stabilization has been a clear goal of the United States policy since the Employment Act of 1946.  

Chapter 33

Chapter 33 is about analyzing short-run fluctuations with aggregate demand and aggregate supply curves. Economic fluctuations are irregular and unpredictable. Most macroeconomic quantities fluctuate together. Real GDP and investment spending have a direct relationship. As real GDP rises, investment spending rises. However, as real GDP rises, unemployment falls. They therefore have an inverse relationship. Most economics believe that classical theory describes the world in the long run but not in the short run. The aggregate demand curve is downward sloping while the short-run aggregate supply curve is upward sloping. The aggregate demand curve is downward sloping because wealthier consumers demand more consumption of goods, interest rates falling increases investment demand, and the depreciation of currency causes more demand of net exports. The aggregate demand curve might shift from changes in consumption, changes in investment, changes in government purchases, and changes in net exports. The long run aggregate supply curve is vertical because a change in the price level does not affect the quantity of goods and services supplied in the long run. The long run aggregate supply curve might shift from changes in labor, changes in capital, changes in natural resources, and changes in technological knowledge. The sticky-wage theory says wages are "sticky" in the short run, meaning that nominal wages are slow to adapt to new economic changes. The sticky-price theory says that prices of some goods are slow to adapt to new economic conditions. Stagflation is the economy experiencing both stagnation (falling output) and inflation (rising prices). Shifts in the aggregate supply can cause stagflation. Policymakers who can influence aggregate demand can potentially reduce the adverse impact on output but only at the cost of worsening the problem of inflation.

Chapter 32

Chapter 32 talks about the causes of macroeconomic variables (like net exports, net capital outflow, and real/nominal exchange rates) and how they are related to each other. The first topic is of two markets and their supply and demand. These markets are the market of loanable funds and the market for foreign currency exchange. The market of loanable funds' supply curve is derived from national saving meanwhile the demand curve is derived from domestic investment and net capital outflow. At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of domestic investment and net capital outflow. The market for foreign currency exchange's supply curve is derived from net capital outflow, meanwhile its demand curve is derived from net exports. The important determinant of net capital outflow is the real interest rate, as was said in the previous chapter. There's a negative relationship between interest rate and net capital outflow. A budget deficit reduces the supply of loanable funds which then increases the real interest rate and reduces net capital outflow. That decrease in net capital outflow reduces the supply of dollars to be exchanged into foreign currency which causes the real exchange rate to appreciate. Trade policies don't affect the trade balance. This is because they don't change national saving or domestic investment. Free trade allows everyone to be better off because everyone specializes in their what they are best at. However, trade barriers/restrictions block these gains from trade and reduce the overall economic well-being, which is why economists usually oppose trade policies. Capital flight is a big and sudden reduction in the demand for assets in a country. 

Chapter 31

Chapter 31 is about open economies, which means there's free trade and interactions between multiple economies. Economies interact in an open economy by buying and selling goods in world product markets and by buying and selling capital assets like stocks and bonds. Balanced trade occurs if exports equals imports. Net exports are the value of a country's exports minus the value of a country's imports. Net capital outflow equals the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. Foreign direct investment differs from foreign portfolio investment because the former actively manages the investment while the latter has a more passive role. Net capital outflow equals net exports. National saving equals Y -C -G. Saving, investment, and international capital flows are all linked and entangled. Saving equals domestic investment plus net capital outflow. The nominal exchange rate is the rate where a person can trade the currency of one country for the currency of another. Appreciation of currency strengthens because it can buy more foreign currency. Currency weakens when it depreciates. The real exchange rate depends on the nominal exchange rate and on the price of goods in the two countries measured in local currencies. Purchasing -power parity is a theory that a unit of currency must have that same real value in all the other countries. If the purchasing power of the dollar is always the same at home and elsewhere, then the real exchange rate can't change. The nominal exchange rate between the currencies of two countries must reflect the price levels in those countries. The theory of purchasing- power parity isn't completely accurate because many goods are not easily traded and even tradable goods aren't always perfect substitutes when produced in different countries.

Chapter 30

Chapter 30 discussed inflation and its causes/ effects. Inflation is the increase in the overall level of prices. Deflation is long periods where most prices fell. Hyperinflation is an extraordinarily high rate of inflation. When the overall price level rises, the value of money falls. In the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply. At the equilibrium price level, the quantity of money that people want to hold exactly balances the quantity of money supplied by the Fed. The equilibrium of the money supply and money demand determines the price level and the value of money. Classical dichotomy is the theoretical separation of nominal and real variables. The difference between real and nominal variables is that real variables are measured in physical units, while nominal variables are measured in monetary units. To calculate the velocity of money, the equation V= ( P X Y ) / M. The quantity theory of money states that growth in the money supply is the primary cause of inflation. The inflation tax is like a tax on everyone who holds money. The Fisher effect is the one-for-one adjustment of the nominal interest rate to the inflation rate. The Fisher effect is a long-run perspective because inflation is unexpected and can't therefore be held in the short-run. Inflation does not in itself reduce people's real purchasing power. Shoeleather costs are the resources wasted when inflation encourages people to reduce their money holdings. The six costs of inflation are: shoeleather costs (reduced money holdings), menu costs (more frequent adjustment of prices), increased variability of relative prices, unintended in tax liabilities, confusing from changing unit of account, and arbitrary redistributions of wealth between creditors and debtors.  

Chapter 29

Chapter 29 talks about the monetary system. Money is the set of assets in the economy that people regularly use to buy goods and services from other people. Money has three functions in the economy: medium of exchange, unit of account, and a store value. Commodity and fiat are two kinds of money. Intrinsic value means that the item would have value even if it were not used as money. Money stock for the US economy includes currency and deposits in banks/other financial institutions that can be easily accessed to buy goods and services. The Federal Reserve was created in 1913 to ensure the health of the nation's banking system. The Federal Reserve System is made up of the Federal Reserve Board in D.C. and twelve regional Federal Reserve Banks across the country. The Fed has two jobs: regulating the banks/ ensuring the health of the banking system and controlling the quantity of money that is made available. The second job is considered more important than the first. Deposits that banks have received but have not loaned out are called reserves. Since all deposits are help as reserves, in this imaginary economy, the system is called 100 percent reserve banking. When banks hold only a fraction of deposits in reserve, banks create money. The money multiplier is the reciprocal of the reserve ratio. The higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier. If banks hold all deposits in reserve, banks do not influence the supply of money. The Fed has three tools in its monetary toolbox: open-market operations (buying/selling government bonds), reserve requirements, and the discount rate. The problems with the Fed's three tools are that the Fed doesn't control the amount of money that households choose to hold as deposits in banks and that it doesn't control the amount that bankers choose to lend.