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Aa-Dd Model

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Aa-Dd Model
Introductory Concepts
Short-Run Model: DD and AA
Liquidity Trap
Macro Policy and CA

Slides for International Finance
Aggregate Demand and the SR (KOM Chapter 17)

Alan G. Isaac
American University

2012-10-22

Alan G. Isaac

Slides for International Finance

Introductory Concepts
Short-Run Model: DD and AA
Liquidity Trap
Macro Policy and CA

AA Curve
Aggregate Demand

PREVIEW
AA Curve review SR model of asset market equilibrium
AA: Y
E (to maintain asset mkt eq)
DD Curve
SR model of output market equilibrium
DD: E
Y (to maintain asset mkt eq)
SR Model
AA + DD: simultaneous output market and asset market equilibrium temporary v permanent changes in monetary and fiscal policies liquidity trap (zero interest rates, deflation, stimulus)
Adjustment of the current account over time.
IS-LM model alternative perspective on the same results

^ _

^ ^

Alan G. Isaac

Slides for International Finance

Introductory Concepts
Short-Run Model: DD and AA
Liquidity Trap
Macro Policy and CA

AA Curve
Aggregate Demand

SR vs. LR Models
LR models all prices of inputs and outputs have time to adjust. predict future exchange rate tendencies suggest ways of thinking about how market participants form expectations SR models some prices of inputs and outputs do not fully adjust labor contracts costs of adjustment imperfect information about market demand.

Goal show how macroeconomic policies affect E, Y, and CA
Alan G. Isaac

Slides for International Finance

Introductory Concepts
Short-Run Model: DD and AA
Liquidity Trap
Macro Policy and CA

AA Curve
Aggregate Demand

Short-Run Equilibrium in Asset Markets

Consider two related asset markets: money market: M/P = L(R, Y)
Y
L
(M/P < L)
R

^ ^ 
^
foreign exchange market: R = R* + (Ee - E)/E
^R  _E
When income (production) increases: the demand for real liquidity increases, driving up the domestic interest rate, causing an
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