14 The IS-LM Model, Part 4 - Agenda Policy Analysis with...

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1 15-1 The IS – LM Model, Part 4 15-2 Agenda • Policy Analysis with the IS – LM Model 15-3 Policy Analysis with the IS – LM Model • Monetary policy: ¾ Changes in the nominal money supply. • Fiscal policy: ¾ Changes in government purchases. ¾ Changes in taxes. 15-4 Policy Analysis with the IS – LM Model • Expansionary policies: ¾ Increases in the nominal money supply. ¾ Increases in government purchases. ¾ Decreases in taxes (no Ricardian equivalence). • Contractionary policies: ¾ Decreases in the nominal money supply. ¾ Decreases in government purchases. ¾ Increases in taxes (no Ricardian equivalence).
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2 15-5 Policy Analysis with the IS – LM Model • Expansionary monetary policy: ¾ Increases in the nominal money supply. 15-6 Expansionary monetary policy Y r Y 0 r 0 FE LM 0 IS 0 15-7 Expansionary monetary policy • An expansionary monetary policy shifts the LM curve to the right. ¾ This increases M s /P directly. ¾ At the initial real interest rate ( r 0 ), M > L , and r begins to fall. ¾ A falling r decreases S d and increases C d and I d , ¾ which increases Y, C d , and M d /P . ¾ This process continues until general equilibrium is re-established. 15-8 Expansionary monetary policy • Net result: ¾ An increase in Y and a decrease in r . ¾ Composition of spending has changed: • Consumption is higher, • Investment is higher, • Government spending is the same.
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3 15-9 Policy Analysis with the IS – LM Model • Monetary policy objectives: ¾ Money supply,
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14 The IS-LM Model, Part 4 - Agenda Policy Analysis with...

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