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Macro1PS2sol2

# Macro1PS2sol2 - Macroeconomics 1 Master APE 2008-2009 TD2...

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Unformatted text preview: Macroeconomics 1. Master APE. 2008-2009. TD2 Prof. Xavier Ragot / T.A : Eric Monnet 1 From IS-LM to AS-AD 2 Dynamic and stability of IS-LM This exercice aims to nd the stability condition of a simple dynamic version of IS- LM. It requires more mathematics than the previous one, and knowledge of phase diagrams. Consider the following short-dynamics in the closed-economy IS-LM model. It is assumed that the price level is xed and (for convenience) has been normalized to unity ( P = 1) : ˙ R = φ 1 [ l ( Y,R )- M ] ,φ 1 > , ˙ Y = φ 2 [ C ( Y- T ) + I ( R ) + G- Y ] ,φ 2 > , where Y is output, R is the interest rate, M is the money stock, C is consumption, T is taxes, I is investment, and G is government consumption. As usual, a dot above a variable denotes the variable's time rate of change, i.e ˙ R ≡ dR dt and ˙ Y ≡ dY dt 1- Interpret these equations The rst equation postulates that the interest rate rises if there is excess de- mand for money and falls if there is excess supply of money. The reasoning linking R and demand for money is as follows : if there is and excess demand, then there is an excess supply of bonds ; bond prices fall and the interest rate rises. Vice versa for and excess supply of money. The second equation postulates that output rises if there is excess demand for goods and fall if there is an excess supply, for example because and excess demand implies a positive change in inventories. 2- Can you say something about the relative speeds of adjustment in the goods and nancial markets ? 1 Macroeconomics 1. Master APE. 2008-2009. TD2 Prof. Xavier Ragot / T.A : Eric Monnet One would expect that the nancial markets (for money and bonds) adjust much more quickly than the goods market. Thus, φ 1 would be much larger than φ 2 . In the limiting case, nancial adjustment is in nitely fast (...
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Macro1PS2sol2 - Macroeconomics 1 Master APE 2008-2009 TD2...

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