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Two words you'll hear thrown a lot in macroeconomic circles
are monetary policy (monetary policy) and
fiscal policy (and fiscal policy),
and they're normally talked about in the context of ways to
shift aggregate demand in one direction or another, and oftentimes to kind of
stimulate aggregate demand to shift it to the right
and what I want to do with this video is focus on what these two different tools are,
who are the actors and how do they go about actually shifting the aggregate demand curve.
So monetary policy, this is literally
deciding how much money to print, so it's literally printing money.
Either deciding to print more of it, or deciding to print less (printing money).
It tends to be done, in the United States especially and most large countries,
it's done by the Central Bank (it's done by the Central Bank)
which is sometimes directly part of the government,
sometimes it's quasi-independent, in the U.S. it's a quasi,
the U.S. Central Bank, which is the Federal Reserve is quasi-independent,
and in the future videos we will talk more about the governance structure of the Federal, of the Federal Reserve.
Most of the major appointees are made by the U.S. government,
all of its excess profits goes back to the U.S. treasury, so in that way it's part of the U.S. government,
but it's set up to be, also has some influence from private industry, the member banks have a stake in what's going on,
it often coordinates amongst member banks.
So you have your Federal Reserve as the Central Bank in the United States, it's quasi-independent,
but it's been given the right to print money.
And I'll just draw it here as physical dollars, but most of the money that it is going to print actually is electronic money.
And the way this affects the aggregate demand curve, the Federal Reserve doesn't just print money and go out and start buying things with that money,
well it does buy things, but it doesn't go out and buy goods and services.
What it does with this is it essentially lends it out, so it's essentially buying debt.
So it buys, it buys debt.
And if buying debt seems like a weird thing to say, buying debt is the same thing as lending money (lending money).
If I buy a treasury bond, so if I'm buying debt,
I'm buying a treasury bond, means I'm implicitly lending that money,
if I buy the bond directly from the government, that means I'm lending that money to the U.S. government.
If I buy, if I directly buy a bond from a U.S. corporation, I'm essentially lending that money to the corporation.
They are going to give me interest payments in the form of coupons, and then they are going to pay back that money at some future date.
So this is essentially lending money.
And what this does is it's increasing the supply of money that's out there to be lent.
And so if we think of the market for money,
so, listen now we have to get microeconomic terms for the market for money,
so the market for money,
if this is the price of money, which is really just the interest rate (so interest, interest rate as a percentage),
and this right over here is the supply of money (supply of money),
and I'll just draw, so this might be our supply curve,
that's supply, and this is the demand curve,
this is the demand curve, and let's say right over here, let's say
and let's say this is short term money and we won't focus on the different durations and all of that,
but let's say we're sitting right over here at a clearing interest rate of 5%.
So it makes sense, this is right here, this is our demand,
our demand curve, so all the people who will get more than 5% benefit out of the money,
maybe they have an investment where they can get 10% on the money or 8%, or 5.1%,
they're all willing to borrow that money and then invest it in whatever they want to do, or this might even be consumption,
people who say "hey, 5%, that's worth it for me to go out and buy that thing that makes me whatever happy."
But from an investment point of view it makes even more sense.
If I'm going to get an 8% return on my money, that's my benefit, it makes sense for me to borrow it at 5%.
And it makes sense all the way up to 5.0001%, I'd actually borrow it.
And so when the Federal Reserve or any Central Bank prints money,
and it buys debt, it goes out into debt markets and it buys it, it usually buys the safest kind of debt, but that affects all of the debt markets,
it goes out and buys in the debt market, they're essentially shifting the supply curve of money to the right,
they shift the supply curve to the right.
And so at any given interest rate you could say that there is more money,
and so the supply curve might look something like that,
and this is interesting because assuming the demand has not shifted,
what you now have is a different clearing price,
a different equilibrium price for the money.
Maybe this is now at 3%.
This is now at 3%.
And you also have more money being lent and borrowed.
So if this is the old quantity of money that was lent and borrowed, let's say that this is, I'm just going to make up a number here,
let's say that this is, let's say that this is one hundred, one hundred billion dollars at some time period,
and now we're at a hundred and twenty billion dollars, one hundred and twenty billion dollars.
So now, by essentially printing money, buying debt, increasing the supply of money, two things happen.
Interest rates went down, and so now you have all of these characters out here who, before,
they weren't going to borrow money at 5% because whatever they were,
their benefit on that money was between 5% and 3%.
Maybe it was 4%, or 3.5%.
It didn't make sense for them to borrow at 5% and invest it and only get a 4% return, a 3% return,
but now that interest rates have gone down,
now it does make sense for them to borrow the money all the way down to someone who has some type of project or investment that has a 3% return.
They also say "hey I'm neutral, I can borrow at 3% and then I can invest."
But definitely the person with 3.1% or 3.2%,
if they have investments that give them that much, they would definitely want to borrow.
And we could assume that all this incremental borrowing, so this little example that I did right over here,
all this incremental twenty billion dollars of borrowing is going to be spent.
People will borrow money not to just, like, not to just sit, but stuff it into their,
into their mattresses, they'll borrow that money to go invest it in some way, to spend it.
And so what this will do, all of this will shift aggregate demand to the right.
Right here we're talking in microeconomic terms, but then if we think about aggregate supply and demand,
so this is aggregate, so this is, let me write aggregate, aggregate right over here,
this is price, this is real GDP, this is our aggregate demand, aggregate, aggregate demand.
And then our short-run aggregate supply might look something like this, aggregate supply in the short-run.
And so if we're shifting aggregate demand to the right, where there's going to be more demand
for goods and services, these people are going to borrow this money and spend it,
you're going to essentially stimulate, you're going to stimulate the economy.
So this shifts to the right, you have a situation
where real GDP will go from this state to this state right over here.
So it was expansionary.
And obviously, if the Federal Reserve decides to print less money, or if they even decide to,
if they essentially soak up the money that's in the market by selling some of the debt that they own,
so that they're sucking dollars out of it, then the opposite effect would happen.
Now fiscal policy is essentially the government directly going out there and demanding goods and services from the economy.
So this is essentially you have the government, you have the government,
it has two sources of revenue that it can spend: it has money from taxes, it has tax revenue,
and then it can go out and borrow money, and so it also has access to debt markets.
And when the government borrows money, they're essentially issuing treasury bills,
if you are talking about the U.S., treasury bills and treasury bonds.
If you were to buy those from the U.S. government, you are essentially lending money to the government to finance their debt.
And so they can take these two sources of money and then,
if they decide to do, if they decide to spend more,
and let's say that they're going to hold taxes fixed,
so they're not going to take out any demand from the economy,
they might ratchet up debt and then ratchet up spending, ratchet up spending,
and then that, the government is directly going out there and demanding more goods and services.
So that could also shift the aggregate demand curve to the right.
So these are two different levers, two different tools that have been used in governments all around the world to shift aggregate demand one way or another
or attempt to shift aggregate demand one way or the other.
Monetary policy is more indirect.
Printing money, using that to increase the supply of money that's out there to be lent,
that lowers interest rates, and then, because it lowers interest rates,
more money, there's more willingness to borrow and invest that money.
Fiscal policy, you're directly going out there and just buying more goods and services by usually ratcheting, ratcheting up your debt.
Or fiscal policy could go the other way.
If you're trying to restrain the economy, you could lower your debt, lower your spending,
or you could do some other combination.