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Chapter 20: Q 9. (page 546)

If large budget deficits cause the public to think there will be higher inflation in the future, what is likely to happen to the short-run aggregate supply curve when budget deficits rise?

Short Answer

Expert verified

The short-run aggregate supply curve will shift upward when there is budget deficit.

Step by step solution

01

Step 1. Define aggregate supply.

Aggregate supply, also known as domestic final supply, is the total supply of products and services that enterprises in a national economy intend to sell over a given time period.

02

Step 2. What is likely to happen to the short-run aggregate supply curve if big budget deficits encourage the public to believe that inflation will rise in the future?

When there is a budget deficit and predicted inflation rises, the short-run aggregate supply curve shifts upward. Inflation rises at each level of output because firms and households expect the Fed to follow policies that cause it to do so. They will want to boost salaries and prices by this amount because they do not want their real wages to fall, which accounts for inflation and is measured in the quantity of goods and services that money can buy.

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Most popular questions from this chapter

What three motives for holding money did Keynes consider in his liquidity preference theory of the demand for real money balances? On the basis of these motives, what variables did he think determined the demand for money?

鈥淧ersistent budget deficits always lead to higher inflation.鈥� Is this statement true, false, or uncertain? Explain your answer

Explain why the aggregate demand curve slopes downward and the short-run aggregate supply curve slopes upward.

Why would a central bank be concerned about persistent, long-term budget deficits?

Go to the St. Louis Federal Reserve FRED database, and find data on the M1 Money Stock (M1SL), M1 Money Velocity (M1V), and Real GDP (GDPC1). Convert the M1SL data series to 鈥渜uarterly鈥� using the frequency setting, and for all three series, use the 鈥淧ercent Change from Year Ago鈥� setting for units.

a. Calculate the average percentage change in real GDP, the M1 money stock, and velocity since 2000:Q1.

b. Based on your answer to part (a), calculate the average inflation rate since 2000 as predicted by the quantity theory of money.

c. Next, find the data on the GDP deflator price index (GDPDEF), download the data using the 鈥淧ercent Change from Year Ago鈥� setting, and calculate the average inflation rate since 2000:Q1. Comment on the value relative to your answer in part (b).
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