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Unformatted text preview: t difference is that now we must clarify that the interest rate on the
vertical axis is the policy rate i s rather than the borrowing rate i b. Once the equilibrium values of Y and
i s have been determined, they can be transferred back to Figures 3A and B to determine the implied
equilibrium values of i b and L as well.
7 Financial Intermediation and Macroeconomic Analysis 33 i s at which intermediaries are able to fund themselves can also increase intermediaries’
aries’ net worth, if (as is often the case) they fund longer-term assets with short-term
borrowing that they must roll over, and in this case a reduction in i s will shift the XS
curve down and to the right as well.
Each of these effects will make the IS curve flatter (more interest-elastic) than
it would otherwise be.8 This means that a shift in the MP curve—due either to a
change in monetary policy or to a supply-side disturbance that shifts the aggregatesupply
supply curve—will have a larger effect on output as a consequence of these “financial
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