Page 713 - The Principle of Economics

THE INFLUENCE OF MONETARY AND FISCAL POLICY ON AGGREGATE DEMAND
Imagine that you are a member of the Federal Open Market Committee, which sets monetary policy. You observe that the president and Congress have agreed to cut government spending. How should the Fed respond to this change in fiscal pol- icy? Should it expand the money supply, contract the money supply, or leave the money supply the same?
To answer this question, you need to consider the impact of monetary and fis- cal policy on the economy. In the preceding chapter we saw how to explain short- run economic fluctuations using the model of aggregate demand and aggregate supply. When the aggregate-demand curve or the aggregate-supply curve shifts, the result is fluctuations in the economy’s overall output of goods and services and in its overall level of prices. As we noted in the previous chapter, monetary and
733
IN THIS CHAPTER YOU WILL . . .
Learn the theory of liquidity preference as a short-run theory of the interest rate
Analyze how monetary policy affects interest rates and aggregate demand
Analyze how fiscal policy affects interest rates and aggregate demand
Discuss the debate over whether policymakers should try to stabilize the economy