Foreign Capital

1. The Inner Loop THE COMPLETE “MONEY” MODEL Rest of the World Banks & Credit Fiscal Policy PrM Spending Exports Investment GovernmentPurchases Consumption LaM FxM CrM TRSY Budget Deficit Foreign Capital Change of Money Demand Change of Money Supply Profit, interest, rent wages Cash The FED (net) Taxes Imports Saving H/B Income Money

2. ABBREVIATIONS X PrM I E G FxM CrM K BB/Def TRSY C ΔMD ΔMS Cash The FED T F S H/B Y

3. THE FULL CLOSED MODEL Rest of the World Banks & Credit Fiscal Policy X PrM I E G FxM CrM K BB/Def TRSY C Sometimes we will ignore ΔMD and/or ΔMS T F S H/B Y

4. THE TREASURY MODEL Often we will ignore the rest of the world Banks & Credit Fiscal Policy X PrM I G CrM BB/Def TRSY C ΔMS ΔMD Cash The FED T S H/B Y

5. THE FOREIGN MODEL Rest of the World Banks & Credit Sometimes we will ignore Fiscal Policy X PrM I E FxM CrM K C ΔMS ΔMD Cash The FED F S H/B Y

6. THE BASIC MODEL Banks & Credit No Government or Foreign Sector X PrM I CrM C ΔMS ΔMD Cash The FED S H/B Y

7. THE CLOSED MODEL – an important conclusion, Part I If we start with a given amount of income (Y), we can picture that money flowing through the economy to where it ends up as spending (X). X PrM I E G FxM CrM K BB/Def TRSY C The rule for this model is: “All the money going into any box will equal the money going out of that box.” Question: “Is it possible that X is ever different from Y?” Answer: “X must always be the same as Y in the CLOSED MODEL” T F S H/B This should sound curious. We have a model that says that total spending (that is, GDP) never changes, when it obviously does in fact change. The model is, nevertheless surprisingly useful particularly as the LONG RUN MODEL. Y

8. THE CLOSED MODEL – an important conclusion, Part I “X must always be the same as Y in the CLOSED MODEL” X PrM I E G FxM CrM K BB/Def TRSY C This is so because the money that leaves Households and Businesses as Income must all go “somewhere.” That money must eventually wind up being spent, since there is nowhere else for it to go. This should sound curious. We have a model that says that total spending (that is, GDP) never changes, when it obviously does in fact change. The model is, nevertheless surprisingly useful particularly as the LONG RUN MODEL for demonstrating Classical/monetarist theory. T F S H/B Y

9. THE CLOSED MODEL – an important conclusion, Part II When we add either of two items to the diagram we get a new conclusion. X PrM I E G With either ΔMD or ΔMS in the model it is now possible for X and Y to be different ΔMD ΔMS FxM CrM K BB/Def TRSY Cash FED C BIG CONCLUSION: In order for GDP (spending) to rise or fall there must be a change in either the money supply or money demand. This is because money going to and from Cash or the Fed is going and coming from “nowhere.” The money more or less appears and disappears from the economy. T F S H/B Y

10. The OPEN Model – the Short Run picture PrM X Injections = Exports, Investment and Government Purchases Once we see that X and Y can be different we can build a simpler model. This is particularly useful for the Keynesian, short-run view of the economy. We will divide the economic flows into three parts. 1. Domestic Consumption: this is the part of income that immediately becomes spending. Cd 2. Leakages: these are the parts of income that are not immediately returned to the product market as spending. 3. Injections: these are the parts of total spending other than domestic consumption: the parts of spending that do not immediately arise out of current income. H/B Y Leakages = Imports, Saving and Taxes

11. The Three Models The OPEN Model the Short Run X The MONEY Model the versatile one. This one can do what either of the others can Injections = E + I + G X X PrM PrM PrM I I E E G G Leakages = F + S + T ΔMD ΔMS FxM CrM FxM CrM K BB K BB TRSY TRSY Cash The CLOSED Model the Long Run FED C C Cd T T F S F S H/B H/B H/B Y Y Y