Monetary and fiscal policy | Aggregate demand and aggregate supply | Macroeconomics | Khan Academy — Transcript

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1. 0:00Two words you'll hear thrown a lot in macroeconomic circles
2. 0:04are monetary policy and fiscal policy.
3. 0:11And they're normally talked about in the context of ways
4. 0:15to shift aggregate demand in one direction or another
5. 0:19and often times to kind of stimulate aggregate demand,
6. 0:21to shift it to the right.
7. 0:23And what I want to do in this video
8. 0:24is focus on what these two different tools who
9. 0:27are, who are the actors, and how do
10. 0:28they go about actually shifting the aggregate demand curve.
11. 0:32So monetary policy-- this is literally
12. 0:35deciding how much money to print.
13. 0:37So it's literally printing money--
14. 0:39either deciding to print more of it or deciding to print less.
15. 0:43It tends to be done in the United States--
16. 0:45especially in most large countries-- it's
17. 0:47done by the central bank, which is sometimes directly
18. 0:52part of the government.
19. 0:54Sometimes it's quasi-independent.
20. 0:56In the US, it's a quasi-- The US central bank, which
21. 0:59is the Federal Reserve, is quasi-independent.
22. 1:02And in future videos we'll talk more
23. 1:04about the governance structure of the Federal Reserve.
24. 1:08Most of the major appointees are made by the US government.
25. 1:12All of its excess profits goes back to the US Treasury,
26. 1:15so in that way it's part of the US government.
27. 1:18But it's set up to be-- also has some influence
28. 1:20from private industry.
29. 1:22The member banks have a stake in what's going on.
30. 1:26It often coordinates amongst member banks.
31. 1:28So you have your Federal Reserve as a central bank
32. 1:31in the United States.
33. 1:31It's quasi-independent, but it's been
34. 1:34given the right to print money.
35. 1:36And I'll just draw it here as physical dollars,
36. 1:38but most of the money that is going to print actually
37. 1:40is electronic money.
38. 1:42And the way this affects the aggregate demand curve,
39. 1:45the Federal Reserve doesn't just print money
40. 1:47and go out and start buying things with that money.
41. 1:49Well, it does buy things, but it doesn't
42. 1:51go out and buy goods and services.
43. 1:52What it does with this is it essentially lends it out,
44. 1:55so it's essentially buying debt.
45. 2:02And if buying debt seems like a weird thing to say, buying debt
46. 2:05it is the same thing as lending money.
47. 2:10If I buy a treasury bond, so if I'm buying debt,
48. 2:13I'm buying a treasury bond means I'm implicitly
49. 2:16lending that money.
50. 2:17If I buy the bond directly from the government,
51. 2:19that means I'm lending that money to the US government.
52. 2:22If I directly buy a bond from a US corporation,
53. 2:26I'm essentially lending that money to the corporation.
54. 2:29They're going to give me interest payments
55. 2:30in the form of coupons, and then they're
56. 2:32going to pay back that money at some future date.
57. 2:34So this is essentially lending money.
58. 2:36And what this does is it's increasing the supply of money
59. 2:39that's out there to be lent.
60. 2:41And so if we think of the market for money-- so let's
61. 2:45see, now we're thinking microeconomic terms
62. 2:47for the market for money.
63. 2:51If this is the price of money, which is really
64. 2:53just the interest rate as a percentage,
65. 2:59and this right over here is the supply of money.
66. 3:04And I'll just draw-- so this might be our supply curve.
67. 3:08That's supply.
68. 3:10And this is the demand curve.
69. 3:14And let's say right over here, this is short-term money.
70. 3:17And we won't focus on the different durations and all
71. 3:19of that.
72. 3:19But let's say we're sitting right over here
73. 3:21at a clearing interest rate of 5%.
74. 3:24So it makes sense.
75. 3:25So this is right here.
76. 3:26This is our demand curve.
77. 3:28So all of the people who will get more than 5% benefit out
78. 3:31of the money-- maybe they have an investment where they could
79. 3:34get 10% on the money or 8% or 5.1%--
80. 3:37they're all willing to borrow that money and then invest it
81. 3:40in whatever they want to do.
82. 3:41Or this might even be consumption,
83. 3:42people who are saying, hey, 5%.
84. 3:44That's worth it for me to go out and buy
85. 3:46that thing that makes me whatever happy.
86. 3:48But from an investment point of view it makes even more sense.
87. 3:49If I'm going to get an 8% return on my money-- that's
88. 3:52my benefit-- it makes sense for me to borrow it at 5%.
89. 3:55It makes sense all the way up to 5.0001%.
90. 3:58I'd actually borrow it.
91. 3:59And so in the Federal Reserve, or any central bank,
92. 4:02prints money and it buys debt.
93. 4:04It goes out into debt markets and it usually
94. 4:06buys the safest kind of debt, but that
95. 4:07affects all of the debt markets.
96. 4:09It goes out and buys debt market.
97. 4:11They're essentially shifting the supply curve of money
98. 4:14to the right.
99. 4:15They shift the supply curve to the right.
100. 4:17And so at any given interest rate
101. 4:19you could say that there is more money.
102. 4:22And so the supply curve might look something like that.
103. 4:26And this is interesting because assuming the demand has not
104. 4:28shifted, what you now have is a different clearing
105. 4:32price, a different equilibrium price, for the money.
106. 4:35Maybe this is now at 3%.
107. 4:40And you also have more money being lent and borrowed.
108. 4:43So if this was the old quantity of money
109. 4:44that was lent and borrowed-- I'm just
110. 4:47going to make up a number here.
111. 4:48Let's say that this is $100 billion in some time period.
112. 4:54And now we're at $120 billion.
113. 4:59So now by essentially printing money, buying debt, increasing
114. 5:02the supply of money two things happen.
115. 5:04Interest rates went down.
116. 5:06And so now you have all of these characters
117. 5:08out here who before, they weren't going to borrow money
118. 5:11at 5% because their benefit on that money
119. 5:14was between 5% and 3%.
120. 5:16Maybe it's 4% or 3.5%.
121. 5:19It didn't make sense for them to borrow at 5%
122. 5:21and invest it and only get a 4% return or a 3% return.
123. 5:25But now that interest rates have gone down,
124. 5:27now it does make sense for them to borrow the money,
125. 5:30all the way down to someone who has some type of project
126. 5:32or investment that has a 3% return.
127. 5:34They also say, hey, I'm neutral.
128. 5:36Now I could borrow at 3%, and then I could invest it.
129. 5:39But definitely the person with 3.1% or 3.2%,
130. 5:41if they have investments that give them that much,
131. 5:43they would definitely want to borrow.
132. 5:45And we could assume that all this incremental borrowing--
133. 5:48so this little example that I did right over here--
134. 5:49all this incremental $20 billion of borrowing
135. 5:52is going to be spent.
136. 5:53People will borrow money not to just sit
137. 5:56but stuff it into their mattresses.
138. 5:58They'll borrow that money to go invest it in some way,
139. 6:01to spend it.
140. 6:02And so what this will do, all of this
141. 6:03will shift aggregate demand to the right.
142. 6:06Right here, we're talking in microeconomic terms,
143. 6:08but then if we think about aggregate supply and demand--
144. 6:11so this is aggregate.
145. 6:14Let me write aggregate right over here.
146. 6:17This is price.
147. 6:18This is real GDP.
148. 6:21This is our aggregate demand.
149. 6:26And then our short run aggregate supply might look something
150. 6:29like this.
151. 6:34And so if we're shifting aggregate demand
152. 6:36to the right where there's going to be more demand for goods
153. 6:39and services, these people are going to borrow this money
154. 6:41and spend it.
155. 6:42You're going to essentially stimulate the economy.
156. 6:47So this shifts to the right.
157. 6:49You have a situation where real GDP will go from this state
158. 6:53to this state right over here.
159. 6:55So it was expansionary.
160. 6:56And obviously, if the Federal Reserve decides
161. 6:58to print less money or if they even
162. 7:01decide to essentially soak up the money that's in the market
163. 7:04by selling some of the debt that they own,
164. 7:07so that they're sucking dollars out of it,
165. 7:09then the opposite effect would happen.
166. 7:11Now fiscal policy is essentially the government
167. 7:14directly going out there and demanding goods and services
168. 7:17from the economy.
169. 7:19You have the government.
170. 7:21It has two sources of revenue that it can spend.
171. 7:25It has money from taxes.
172. 7:27It has tax revenue.
173. 7:28And then it can go out and borrow money.
174. 7:30And so it also has access to debt markets.
175. 7:34And when the government borrows money,
176. 7:36they're essentially issuing treasury bills,
177. 7:38if you're talking about the US Treasury Bills and Treasury
178. 7:40Bonds.
179. 7:40If you were to buy those from the US government,
180. 7:42you're essentially lending money to the government
181. 7:44to finance their debt.
182. 7:47And so they can take these two sources of money,
183. 7:49and then if they decide to spend more-- and let's
184. 7:53say that they're going to hold taxes fixed.
185. 7:55So they're not going to take out any demand from the economy.
186. 7:57They might ratchet up debt and then ratchet up spending.
187. 8:03And then this government is directly
188. 8:05going out there and demanding more goods and services.
189. 8:09So that could also shift the aggregate demand curve
190. 8:12to the right.
191. 8:12So these are two different levers, two different tools,
192. 8:15that have been used in governments
193. 8:17all around the world to shift aggregate demand one way
194. 8:20or another or an attempt to shift aggregate demand one
195. 8:23way or the other.
196. 8:23Monetary policy is more indirect.
197. 8:25Printing money, using that to increase the supply of money
198. 8:28that's out there to be lent, that lowers interest rates.
199. 8:32And then because it lowers interest rates,
200. 8:35there's more willingness to borrow and invest that money.
201. 8:38Fiscal policy, you're directly going out there and just buying
202. 8:42more goods and services by usually ratcheting up
203. 8:45your debt.
204. 8:46Or fiscal policy could go the other way.
205. 8:47If you're trying to restrain the economy, you could lower
206. 8:49your debt, lower your spending, or you
207. 8:51could do some other combination. s