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

Two words you’ll hear thrown
a lot in macroeconomic circles are monetary 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 often times to kind of
stimulate aggregate demand, to shift it to the right. And what I want to
do in this video is focus on what these
two different tools who 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. It tends to be done
in the United States– especially in most
large countries– it’s done by the central bank,
which is sometimes directly part of the government. Sometimes it’s
quasi-independent. In the US, it’s a quasi–
The US central bank, which is the Federal Reserve,
is quasi-independent. And in future videos
we’ll talk more about the governance structure
of the Federal Reserve. Most of the major appointees
are made by the US government. All of its excess profits
goes back to the US Treasury, so in that way it’s part
of the US 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 a 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
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. And if buying debt seems like a
weird thing to say, buying debt it is the same thing
as 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 US government. If I directly buy a bond
from a US corporation, I’m essentially lending that
money to the corporation. They’re going to give
me interest payments in the form of coupons,
and then they’re 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 let’s see, now we’re thinking
microeconomic terms for the market for money. If this is the price of
money, which is really just the interest
rate as a percentage, and this right over here
is the supply of money. And I’ll just draw– so this
might be our supply curve. That’s supply. And this is the demand curve. And let’s say right over here,
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. So this is right here. This is our demand curve. So all of the people who will
get more than 5% benefit out of the money– maybe they have
an investment where they could 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 are saying, 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%. It makes sense all
the way up to 5.0001%. I’d actually borrow it. And so in the Federal
Reserve, or any central bank, prints money and it buys debt. It goes out into debt
markets and it usually buys the safest kind
of debt, but that affects all of the debt markets. It goes out and
buys 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%. And you also have more money
being lent and borrowed. So if this was the
old quantity of money that was lent and
borrowed– I’m just going to make up a number here. Let’s say that this is $100
billion in some time period. And now we’re at $120 billion. 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 their
benefit on that money was between 5% and 3%. Maybe it’s 4% or 3.5%. It didn’t make sense
for them to borrow at 5% and invest it and only get
a 4% return or 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. Now I could borrow at 3%,
and then I could invest it. 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
$20 billion of borrowing is going to be spent. People will borrow
money not to just sit but stuff it 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. Let me write aggregate
right over here. This is price. This is real GDP. This is our aggregate demand. And then our short run aggregate
supply might look something like this. 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 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 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. 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’re talking about the
US Treasury Bills and Treasury Bonds. If you were to buy those
from the US government, you’re 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 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. And then this
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 an 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, 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 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. s

About James Carlton

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84 thoughts on “Monetary and fiscal policy | Aggregate demand and aggregate supply | Macroeconomics | Khan Academy

  1. This was the one topic I really had brief knowledge about for my Macroeconomics mock exam tomorrow, I'm now so glad I stayed up for these extra 10 minutes to watch this video! 😀 Thanks alot



    Listen why not give ME the power to print money? I'D LOVE THAT POWER. They aren't "quasi public", they are PRIVATE ECONOMIC ACTORS, who is kept secret, tending to their own interests.

  4. @wisdomtrek He's mostly talking theory, which he is doing perfectly. Those things are for future video's or not at all since they are not relevant to the theory itself.

  5. When you say the Central bank buys debt, you mean to say that it buys back the bonds that it had sold to the bond/debt holders? Thereby infusing money into the economy. You could also talk about other things like Repo, Reserve repo, those are some major monetary policy instruments in India atleast.

  6. @wisdomtrek Any profit above '0' is considered excess. It's not the same meaining as having excess as in "too much."

    And secondly you can print money. All you have to do is convince someone to accept "your money for goods and services." Your money is not "US Legal Tender".

  7. Check out the Planet Money podcast. They've done some really great stories on Monetary Policy and the Fed.

  8. Khan, federal reserve lends money to the federal government? Then why does the federal reserve give all its profits to the u.s. treasury? So if i understand you, Fed lends money to government, so government is in debt to fed, but fed gives government its profits? where does fed get its profits from?

  9. The only problem with this video is that the supply of money in normally shown as a vertical line since it is 100% controlled be the Fed. Also, the horizontal axis should be "Quantity of Money" not "supply of money."
    Interesting tie-in to fiscal policy. I'm going to be checking additional videos from Khan Academy and be assigning them to my classes. I suggest also Jason Welker's work and that of Steve Reff ("Reffonomics"), both are excellent and designed specifically for AP Econ.

  10. Wowzers5…. The Fed profits come from the interest the government pays on the ton of US bonds and Treasuries that the Fed holds… And yes, the Fed is VERY profitable…

  11. Sorry, I support some of his policies and his views but I think his economic policies are a little too radical for a modern day economy.

  12. In “Occupying Chairlifts” a simple rule tweak on inheritance ends up changing the direction and purpose of modern human life! Here’s a fair way to transition forward to where we’re rewarded for cooperating and creating instead of competing and conquering.
    It's something specific we can demand. If this isnt the best answer, at least we’re thinking about what might be. Are we really just this close to having it work right?
    Oh yeah, it's a Ski movie! “Occupying Chairlifts” on Youtube!

  13. Pls don't talk down to me, by virtue of the fact its antagonistic. Am I aware of Benjamin Shalom Bernanke being the chairmen of the Federal Reserve System? Yes I am. Is he a member of the economic interests the ACTUALLY OWN THIS PRIVATE BANKING CARTEL? I don't believe so, admittedly speculative ….again the Amerikan body politic isn't privy to the stockholders of this institution; I can assure u though a Rothschilds name or two is amongst the personages.

  14. Question for Khan: Let's say a fictional country would make it a constitutional law that the government is not allowed to borrow money for > 0% interest anymore.. ever… What scenario's are most likely during…:
    – the period in which they are paying off all the debt
    – the longer term after they have paid off the debt and the economy is used to the new situation.
    What kind of effects would such a policy have?

  15. In “Occupying Chairlifts” a simple rule tweak on inheritance ends up changing the direction and purpose of modern human life! Here’s a fair way to transition forward to where we’re rewarded for cooperating and creating instead of competing and conquering.
    It's something specific we can demand. If this isnt the best answer, at least we’re thinking about what might be. Are we really just this close to having it work right?
    Oh yeah, it's a Ski movie! “Occupying Chairlifts” on Youtube!

  16. I think you should discuss what a debt ceiling is. I'm tired of hearing about it and knowing practically nothing about it.
    My friend who DOES understand this stuff is supremely UNconcerned about what a government shutdown will do to ordinary people. I OTOH wonder about it.

  17. I always confuse about interest rate. In this topic, what interest rate are you using? Is it the prime rate, fed rate or treasury bills rate. How are those rate related. If you said that the rates increased, does it mean that all kind of interest rate increase as well? 

  18. The Federal Reserve does not print money. The Bureau of Engraving and Printing, which is part of the Treasury Department, prints it. The Federal Reserve then purchases it.

  19. Instead of literally printing money, cant the federal reserve just buy and sell bonds to increase/decrease the money supply?

  20. How come its the same voice for nearly every Khan Adcademy video that I have ever listened to, This guy must know everything that is needed to know about everything!

  21. Thanks Khan Academy, I love watching your vids because I can't afford college right now and this is what I'd want a degree in if I could, along with Political Science 🙂

  22. What the fuck is this Khan guy??? Does he know everything of everything about university classes and courses/subjects.
    I wish you were my uncle

  23. Money supply curve should be vertical, not sloped, since there is only ONE dollar amount in existence at any given time.

  24. thats a very good explanation. Guys, you can also view our video on this topic in our channel:

  25. i want to ask a question with illustration what will happen to out put and price level when central bank loosen its policy
    b.when goverment increases taxes
    c.when the goverment increases its spendings

  26. Not all money is printed, actually just a little is, please use correct terms. I recommend you say Creating Money instead of Printing.

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