This preview shows pages 1–5. Sign up to view the full content.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Unformatted text preview: 10/27/2010 1 The complete ISLM model Juan Carlos Cordoba ISU October 2010 Economic Fluctuations Equilibrium in Asset Markets The LM Curve y Equilibrium in asset markets requires: N + = , t t t s t r Y L P M y The ISLM model assumes that in the short term P t is fixed and that P t+1 only responds slowly to changes in aggregate conditions. y Therefore, t =(P t+1P t )/P t is mostly fixed y Furthermore, M t s is assumed to be controlled by the monetary authority (in other words, M t s is exogenous). y Under these assumptions the equation above describes a relationship between output (Y ) and real interest rates (r ). + ) ( ) ( t P t t y This relationship is positive y A higher output ( Y) would increase real money demand, L. y To restore the equilibrium in asset markets, the real interest rate (r) should increase: r should increase to reduces L to its original level. 10/27/2010 2 Asset Market Equilibrium The LM Curve LM curve: (r,Y) combinations such that asset markets are in equilibrium. M s /P r r r r L(Y 1 ,r+ ) r 1 r 1 LM curve M s /P Equilibrium pair Equilibrium pair M/P Y L(Y ,r+ ) Y Y 1 Money Supply Increase and the LM Curve M s M s 1 r r r r r 1 LM LM 1 P P 1 Asset Market Equilibrium M/P Y L(Y ,r+ ) Y 1 r 1 The LM Curve 10/27/2010 3 Price Reduction ( P 1 <P ) and LM Curve M s M s r r r r r 1 LM LM 1 P 1 P Equilibrium in Asset Markets M/P Y L(Y ,r+ ) Y 1 r 1 The LM Curve M s /P An increase in the Real Money Demand: Financial Crisis ( L 1 >L ) LM r r r r L 1 (Y ,r+ ) r 1 r 1 LM M s /P LM 1 Asset Market Equilibrium M/P Y L (Y ,r+ ) Y The LM Curve 10/27/2010 4 Long Run General Equilibrium in the Complete IS LM Model LM = Equilibrium is asset markets trate,r FE = Equilibrium in factor markets realinteres r* General Equilibrium (Good, asset & factor markets) IS = Equilibrium in goods markets Y Fullemployment output (FE line) Output, Y 10/27/2010...
View
Full
Document
 Fall '08
 Staff

Click to edit the document details