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Figure 24.3 (Macro 11) A Monetary Policy Rule

Figure 24.3 (Macro 11) A Monetary Policy Rule

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Monetary Policy Rule

• The monetary policy rule in Figure 24.3

shows that central banks raise the interest

rate when inflation rises and lower it when

inflation declines.

• The dashed line has a slope of 1. Monetary

policy rule has a bigger slope: Nominal

interest rate is increased by more than

inflation, so that the real interest changes.

Note that AE decisions depend on real

rate.

Copyright â 2001 by H



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STAGE 3: Deriving AD curve

• When inflation increases, two things happen:

(1) Central banks raise the nominal interest rate

more than inflation, raising the real interest rate

(2) The higher real interest rate will decrease

real GDP because of lower AE

• Just the opposite happens when inflation

decreases

• Thus, AD curve shows a negative link between

real interest rates and real GDP



Copyright © 2001 by H



21



Figure 24.4

(Macro 11)

A Self-Guided

Graphical Overview



Copyright © 2001 by H



22



Movements along the AD curve

• A change in inflation causes a movement

along the demand curve

• When inflation rises and the Fed raises the

interest rate and real GDP declines. This

causes a movement up and to the left along

the AD curve.

• When inflation decreases, there is a

movement down and to the right.

Copyright © 2001 by H



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Figure 24.3 (Macro 11) A Monetary Policy Rule

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