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However the dependence of the supply of

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Unformatted text preview: es as the standard IS–MP model (which is simply the special case in which the curve XS is assumed to be horizontal at ω = 0). However, the dependence of the supply of intermediation on the capital of intermediaries provides a channel for the amplification and propagation of the effects of economic disturbances. An increase in aggregate economic activity will generally increase the value of intermediaries’ assets (loans are more likely to be repaid, land prices increase with increases in income, and so on) and hence their net worth. This will allow additional borrowing by the intermediaries, and hence a larger larger volume of credit for any given credit spread. Thus, the supply of intermediation tion schedule XS will shift down and to the right. A reduction in the interest rate In fact, we can now solve for both i s and i b as functions of Y, but it is the relation between i s and Y that is relevant for the IS–MP diagram, since it is i s—the rate at which intermediaries are able to fund themselves—that corresponds to the operating target of the central bank. Plotting again the reaction of the central bank’s target for i s to changes in economic activity as a curve MP, we again have a diagram of exactly the kind shown in Figure 2B to determine simultaneously the equilibrium values of the interest rate and output; the only importan...
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This note was uploaded on 11/23/2013 for the course ECON 11837649 taught by Professor Batchelder during the Spring '10 term at Pepperdine.

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