Answer to Question #57725 in Macroeconomics for henry

Question

Consider the effects of an exogenous increase in the domestic price level. For each of the assets listed, explain how the change in the price level would affect the wealth of the asset holder. Then explain the effect on aggregate (private sector) wealth and how the AE would shift in each case.

a) Cash holdings
b) A household mortgage

Answer 1

If there is an exogenous increase in the domestic price level, then:
a) Cash holdings will loss its value, because with the increase of the price level the value of money will decrease. The aggregate (private sector) wealth will decrease too, and consumers will spend less, so the aggregate expenditures (AE) will shift to the left.
b) A household mortgage will cost less, because the real value of payments will decrease, that's why the wealth of asset holder will increase. The aggregate (private sector) wealth will increase too, and consumers will spend more, so the aggregate expenditures (AE) will shift to the right.