DEFINITIONS - DEFINITIONS Week 6 IS-LM Model A model...

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DEFINITIONSWeek 6IS-LM Model: A model showing that the interaction between the IS and LM curves determines the interest rate and the level of income for a given price level,for which both the goods market and the money market are in equilibrium.Goods Market Equilibrium: Combination of interest rates and level of output where investment = savings IS Curve: A schedule showing all the combinations of interest rates and level of output for which the goods market is in equilibrium.Real Money Balances:Number of units of goods that a given stock of money willbuy M/PDemand for Real Balances:The quantity of real money that people wish to holdLM Curve: A schedule depicting all combinations of income and interest rates forwhich there is equilibrium in the money market (demand for real money = supply for real balances). Money Market:Combination of interest rates and level of output for which money demand = money supply. Fiscal Policy Multiplier: How much an increase in government spending changes the equilibrium level of income, holding the real money supply constant. Monetary Policy Multiplier:How much an increase in the real level of the money supply increases the equilibrium level of output, holding fiscal policy constant.Wealth Constraint: Finite supply of wealth that Week 7:Open Market Operation:Purchase or sale of bonds by the central bank in exchange for money. *(Note: Purchase: increases money supply, Sale: decreases money supply)Transmission Mechanism: The process by which monetary policy affects aggregate demand.Portfolio Disequilibrium:When people are holding more of an asset (i.e. money) then they wish to at the prevailing interest rate. *(This is the first stage of the transmission mechanism)
Liquidity Trap:When people hold any level of money that the central bank supplies. Horizontal LM curve due to the extreme interest sensitivityof money demand. (*don’t get why extremely sensitive, but look at formula!)Classical Case:A vertical LM curve, caused by 0 interest sensitivity of money demand causing people to hold the same money balance regardless of the interest rate. Quantity theory of Money:A theory of money demand emphasizing the relationship between nominal money supply and nominal income. Often used to mean a vertical LM curve (supports the classical case). M.V=P.YCrowding Out: The reduction of aggregate demand (usually investment) that results from the increased in interest rates from an increase in government spending. Monetary Accommodation: Use of monetary policy to stabilize interest rates during active fiscal policy operations. Also the use of monetary policy to prevent a supply shock from negatively affecting output.Monetising budget deficits: Using monetary policy to stabilize interest rates during active fiscal policy operation. Also using monetary policy to reduce the negative output effects of a supply shock.

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