- Unemployment to rise from 5.7 to 6.1 this year, up to 7% by fall 2009
- Treasury to rescue Fannie, Freddy: injecting capitol into these companies so that they have enough capitol to continue operation and to drive down interest rates. The FED lowering rates didn't cause people to invest in mortgage type investments (seems risky after what happened).
- Fannie May: big deal for a gov't sponsored mortgage lending company. The gov't has yet to decide whether or not the organizations need to remain gov't controlled or be restructured. Mortgage rates projected to fall to 5.25-5.5 percent.
- Professors opinion: you don't need a gov't sponsored lending company, it should be a free, private market. Continual bail-out of companies may create problems down the road, companies should fail in the free market system.. Most of the current situation has been brought on by past gov't intervention. (All opinion from the professor)
Upcoming TEST 1 (9/14/08):
- Know what's going on with GDP, inflation, current events, and read the book and your notes...don't rely on the slides posted on D2L.
Classical Macroeconomics (Money, Prices, & Interest):
- Focusing on aggregate demand in chapter 4, we focused on aggregate supply in chapter 3
- Aggregate supply stabilized through labor supply. Aggregate demand stabilized through the loanable funds market.
- Irving Fisher established the equation of why people want money? To buy things...transactions demand money.
- Turn-over of money: recirculates and is reused
- Velocity of Money - rate at which money turns over in GDP transactions during a given period of time.
- Quantity Theory - the classical theory that states that he price level is proportional to the quantity of money in circulation.
Equation of Exchange (An identity):
- MVt = PtT
- Developed by Irving Fisher
- M = quantity of money
- V = Velocity of money
- P = price level
- T = volume of transactions
Equation of Exchange and GDP:
- If all transactions are for current production then the equation of exchange can be written: MV=PY where Y=GDP (Nominal)
- V is determined by institutional factors and does not change in the short run and Y is fixed by production conditions
- In this case, the price level is determined by the quantity of money
- The velocity of money is relatively stable in the short run because the money supply is created, maintained, and controlled by institutions
- GDP is also fixed (vertical line on short run graph)
- Considering these two above conditions, if money goes up, the price level goes up and vice versa (in the short run).
The Cambridge Approach:
- A version of the quantity theory that focuses on the demand for money
- Developed by Alfred Marshall and A.C. Pigou
- Md = kPY (A manipulation of Fisher's equation)
- Md = money demand
- k = proportion of income held as money
- k = 1/V
- This has to do with behavioral relationships, where-as Fisher's equation wasn't' behavioral
Money and Prices, The Cambridge Explanation:
- Starting at equilibrium (money demand equals money supply), suppose the stock of money increases
- The increase in the quantity of money creates an excess supply of money
- Individuals react by increasing consumption and investment spending
- Demand for commodities rises and prices rise because production is fixed
Aggregate Demand:
- The quantity theory is an implicit theory of aggregate demand
- Demand is a relationship between the price level and the quantity individuals are willing and able to buy
- Using the quantity theory this is expressed as P = (VM)/Y
- The price level, P, and GDP, Y, are inversely related (See figure 4.2)
- As money and demand are increased, price levels rise because output is constant in the short run
Shifts in Aggregate Demand:
- Increase in demand causes price levels to rise and vice versa
Money and Hyperinflation:
- 1985-1995
- Prices rising almost equally to money rise
Classical Interest Rate Theory (Not controversial):
- Saving is directly related to interest rates
- Consumption is inversely related to interest rates
- Investment is inversely related to interest rates
Gov't funds:
- Taxation
- Borrowing in the loanable funds market (tends to increase interest rates)
- Money creation (from FED)
Demand for Loanable Funds:
- Demand for loanable fund shows the relationship between the interest rate and the amount of borrowing
- Borrowing is composed of borrowing for: Private investment & Gov't purchases
- Gov't and businesses borrow by selling bonds
- Borrowing is inversely related to the interest rate
Figure 4.3 Interest Rate determination in the Classical System:
- With gov't borrowing it drives investment and interest rates up. It also crowds out some private investment (less profitable investments at higher interest rates).
- Not everything has the same ROI, at higher interest rates certain projects get cut off. At higher interest rates some profitable opportunities are no longer profitable.
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