Parts 8-9: Macroeconomics, Money and National Economy (Ch25-Ch29)

Part 8. Determination of National Income

Chapter 25. Keynes’s Effective Demand Theory

This chapter covers the determination of national income, which is the foundation of macroeconomics, and the Keynesian Revolution.

1. Divergence of Views: Classical vs. Keynesian

Classification	Classical	Keynesian
Core Argument	Say’s Law (Supply creates its own demand)	Effective Demand Theory (Demand creates supply)
Price Variable	Flexible (Perfect market clearing)	Sticky downwards (Union and institutional constraints)
Causes of Recession	Merely temporary frictions	Absolute shortage of aggregate demand (effective demand)
Function of Saving	Virtue fully translated into investment	Paradox of Thrift (Increased saving during a recession = vice)
Government Policy	Invisible hand (Laissez-faire)	Active fiscal policy

2. Flow of National Income and Leakages/Injections

• Leakage: Parts of the national income flow that escape the circular flow, such as savings, taxes, and imports.
• Injection: New elements entering the circular flow of national income, such as investment, government spending, and exports.
• Paradox of Thrift: A phenomenon where if individuals reduce consumption spending to increase savings, aggregate demand decreases, leading to reduced production and income, which may ultimately reduce the total amount of saving in the entire national economy.

3. Expansionary Fiscal Policy Stance

Theoretically, national income is increased by a magnitude greater than the initial expenditure through the Multiplier Effect.

1. Maintain tax revenues, increase government spending
2. Maintain government spending, cut taxes
3. Maintain balanced budget, increase government spending (spending = increase in taxes)

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Chapter 26. National Income and the Price Level: AD-AS Model

1. Why the Aggregate Demand (AD) Curve Slopes Downward

When the price level falls, aggregate demand ($Y$) increases through the following channels:

1. Real Wealth Effect (Pigou Effect): Price level $\downarrow$ $\rightarrow$ Real value of held assets (money) $\uparrow$ $\rightarrow$ Household consumption $\uparrow$
2. Interest Rate Effect (Keynes Effect): Price level $\downarrow$ $\rightarrow$ Money demand $\downarrow$ $\rightarrow$ Interest rate $\downarrow$ $\rightarrow$ Corporate investment $\uparrow$
3. Net Export Effect (Mundell-Fleming): Price level $\downarrow$ $\rightarrow$ Relative price of domestic goods $\downarrow$ $\rightarrow$ Exports $\uparrow$, Imports $\downarrow$ $\rightarrow$ Net exports $\uparrow$

2. Short-Run Equilibrium and Long-Run Adjustment in AD-AS

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Part 9. Money and the National Economy

Chapter 27. The Money Market and Interest Rate Determination

1. Classification of Monetary Aggregates (Based on the Bank of Korea)

Aggregate	Components	Characteristics
M1 (Narrow Money)	Currency in circulation + Settlement deposits	Narrowest money, highest liquidity
M2 (Broad Money)	M1 + Time and savings deposits, CDs, RPs, beneficiary certificates	Core monetary management aggregate of the Bank of Korea
Lf (Liquidity of Financial Institutions)	M2 + Mutual savings banks, long-term products with maturity of 2 years or more	—
L (Broad Liquidity)	Lf + CPs, corporate bonds, government and public bonds	Broadest concept of money

2. Keynes’s Liquidity Preference Theory (Determination of Money Demand)

The three motives for holding money:

1. Transactions Motive (Function of $Y$, +): Funds for routine transactions. Increases as income rises.
2. Precautionary Motive (Function of $Y$, +): For unforeseen future uncertainties.
3. Speculative Motive (Function of $R$, -): The higher the interest rate, the more attractive bond investment becomes, leading to a sharp drop in money (cash) demand.

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Chapter 28. Monetary and Fiscal Policy Debates

1. Policy Views: Keynesians vs. Monetarists

Comparison Item	Keynesians	Monetarists (Friedman)
Market Trust	Distrust (Government intervention essential)	Trust (Self-correcting mechanism possible)
Preferred Policy	Fiscal policy	Monetary policy (K% rule)
Criticism of Fiscal Policy	Inside lag issues	Crowding-out effect (Sacrificing private investment)
Criticism of Monetary Policy	Liquidity traps, unclear transmission channels	Outside lags are too long, hindering stability

2. Policy Lags and Discretion vs. Rules

• Inside Lag: Delay until policy formulation and legislative decisions. Fiscal policy > Monetary policy.
• Outside Lag: Delay until real effects manifest after implementation. Monetary policy > Fiscal policy.
• Discretion: Keynesian fine-tuning approach.
• Rules: Friedman’s K% rule — adhering to a constant money growth rate every year.

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Chapter 29. Deposit Creation by Banks and Money Supply Control Instruments

1. Deposit Creation (Credit Creation) and the Money Multiplier

Banks create money (credit) greater than the monetary base by keeping a fraction of deposits as required reserves and continually lending out excess reserves.

• Monetary Base ($H$): Currency held by the public + Reserves deposited by financial institutions
• Money Multiplier ($m$): $M / H = 1 / \text{Reserve Ratio } (z)$

2. The Central Bank’s Three Monetary Policy Instruments

Instrument	Content	Characteristics
Open Market Operations	Adjusting monetary base by buying/selling government and public bonds	Most routine, excellent for fine-tuning
Discount Rate Policy	Adjusting lending rates to commercial banks	Medium transmission intensity
Reserve Requirement Policy	Changing statutory reserve ratios	Strong impact, used as a last resort