Lecture5_ISLM - EC3024 Managerial Macroeconomics Goods and...

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EC3024 Managerial Macroeconomics Goods and Financial Markets: The IS-LM Model and Expectations
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The IS-LM Model without Expectations Equilibrium in the goods market implies that an increase in the interest rate leads to a decrease in output. Equilibrium in financial markets implies that an increase in output leads to an increase in the interest rate. Only at point A, which is on both curves, are both goods and financial The IS–LM Model Figure 5 - 6 2 I S r e l a t i o n : Y C Y T I Y i G ( ) ( , ) L M r e l a t i o n : M P Y L i ( )
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Fiscal contraction, or fiscal consolidation, refers to fiscal policy that reduces the budget deficit. An increase in the deficit is called a fiscal expansion. Fiscal policy affects the IS curve, not the LM curve. For example, an increase in government spending shifts the IS curve to the right. Fiscal Policy, Activity, and the Interest Rate 3 The IS-LM Model without Expectations
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The IS-LM Model without Expectations Fiscal Policy, Activity, and the Interest Rate The Effects of an Increase in Taxes Figure 5 - 7 4 A fiscal contraction leads to lower output and a lower interest rate.
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The IS-LM Model without Expectations Monetary contraction, or monetary tightening , refers to a decrease in the money supply. An increase in the money supply is called monetary expansion. Monetary policy does not affect the IS curve, only the LM curve. For example, an increase in the money supply shifts the LM curve down. Monetary Policy, Activity, and the Interest Rate 5
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The IS-LM Model without Expectations Monetary Policy, Activity, and the Interest Rate A monetary expansion leads to higher output and a lower interest rate. The Effects of a Monetary Expansion Figure 5 - 8 6
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The IS-LM Model without Expectations Table 5-1 The Effects of Fiscal and Monetary Policy Shift of IS Shift of LM Movement in Output Movement in Interest Rate Increase in taxes Left None Down Down Decrease in taxes Right None Up Up Increase in spending Right None Up Up Decrease in spending Left None Down Down Increase in money None Down Up Down Decrease in money None Up Down Up 7 The combination of monetary and fiscal polices is known as the monetary-fiscal policy mix , or simply, the policy mix .
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Changes in any variables in other than Y and r , shift the IS curve: Changes in T (current taxes) or G (current government spending) shift the IS curve. T ↑ IS curve to the left G ↑ IS curve to the right Changes in expected future variables also shift the IS curve. Y’ e IS curve to the right T’ e IS curve to the left r’ e IS curve to the left The IS-LM Model with Expectations Expectations and the IS Relation 8 ( , , , ' , ' ' )       e e e Y A Y T r Y T r G ( , , )  ,    +,      
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The IS-LM Model with Expectations
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