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In particular the curves are shown assuming a

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Unformatted text preview: her than the current interest rate. In particular, the curves are shown assuming a particular level of current-period aggregate output (and hence income) Y. A higher level of income should increase the supply of loans higher at any given interest rate (as not all of the additional income should be consumed if future income expectations are held fixed); hence an increase in Y should shift Michael Woodford 27 Figure 2 Interest-Rate and Output Determination in the Standard Model A: Effect of an Increase in Aggregate Income on Loan Supply and Demand i Interest rate LS i1 i2 LD L1 L2 Volume of lending L B: Effect of a Loosening of Monetary Policy on Interest Rates and Output Interest rate i MP i1 i2 IS Y1 Y2 Y Aggregate income Notes: In panel A, LS is the loan supply schedule and LD is the loan demand schedule, which are specified holding constant aggregate income, Y. The arrows show how the curves shift with an increase in Y. Panel B shows an IS schedule, derived by tracing out the equilibrium interest rate for any assumed level of current income Y, and a monetary policy reaction function (MP ), showing how the central bank’s interest rate target will vary with the level...
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