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Unformatted text preview: le—for either exogenous or endogenous reasons—become
an additional source of variations in aggregate demand, and hence in economic
activity and inflation.9 A disruption of the supply of intermediation will shift the
XS schedule up, so that financial intermediaries supply less credit at every level
of the credit spread ω. As shown in Figure 4A an upward shift in XS results in a
higher equilibrium credit spread, and a lower volume of lending, for any given level
of economic activity (reflected in the location of the XD schedule in the figure).
Transferring this larger spread back to Figure 3A, one observes that the implied
value of i s will be smaller, and the implied value of i b higher, for the given value of
Y. Because this is true for each possible value of Y, the IS schedule is shifted down
and to the left, as shown in Figure 4B. (Note that IS plots the equilibrium value of
i s rather than that of i b, because the policy reaction function specifies a target for
i rather than for i .) In the absence of any change in the monetary policy reaction
Of course, these reasons for the IS cur...
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