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EC489Lecture4 - EC489.01 Special Topics in Economics...

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EC489.01 Special Topics in Economics: Macroeconomics Lecture 4
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Applying the IS-LM Model IS Curve representing the equilibrium in the market for goods and services Keynesian cross and Investment function LM Curve representing the equilibrium in the market for real money balances The theory of liquidity preference and quantity- equation interpretation IS-LM model determine r & Y in the SR (fixed prices)
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Plan for Today Potential causes of fluctuations in national income: Change in exogenous vars (G, T and M) Shocks to goods market or to money market Impact on endogenous vars: r and Y Discuss how IS-LM model fits into AS-AD model Slope and position of AD curve Relaxing fixed price assumption showing the negative relationship btw P and Y Have a look into economic downturns Aggregate supply and SR tradeoff btw inflation and unemployment
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Fiscal Policy, IS Curve and the Short Run Equilibrium Fiscal policy influences IS Curve through Keynesian Cross uni0394Guni2191 uni003Duni003E Planned Expenditure shig332s (Keynesian Cross) uni003Duni003E IS Curve shifts uni0394G/(1-MPC) (multiplier effect) uni0394Guni2191 uni003Duni003E Euni2191 uni003Duni003E Yuni2191 uni003Duni003E runi2191 uni003Duni003E I↓ uni003Duni003E Y ↓ Goods marketuni003Duni003EMoney marketuni003Duni003EGoods market Crowding out of investment due to higher r Same story for tax decrease expect shift in IS curve is uni0394T*MPC/(1-MPC)
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An increase in Money Supply shifts LM curve downward for any given level of income, lowering the interest rate Muni2191uni003Duni003Er↓uni003Duni003EIuni2191uni003Duni003EYuni2191 Monetary Policy, LM Curve and the Short Run Equilibrium Monetary expansion leads to higher spending: Monetary transmission mechanism (Close economy assumption-ignoring the exchange rate)
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Interaction between Monetary and Fiscal Policy Coordination of policymakers An example: Tax increase How does CB react? Constant money supply: lower interest partially offsetting the tax hike Constant interest rate: deepens recession due to keeping interest rate high Constant income: Recession avoided, but allocation of resources changed (higher investment, lower consumption)
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Shocks in the IS-LM Model Shocks to IS Curve Animal spirits: exogenous and sometimes self- fulfilling waves of optimism and pessimism Pessimism about the futureuni003Duni003Elower demand for investmentuni003Duni003Einvestment function shiftsuni003Duni003Ereduced planned expenditureuni003Duni003Eshift IS curveuni003Duni003Elower income Shift can also come from consumer good demand
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