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Unformatted text preview: es: XS and XD are the supply and demand for intermediation. ω is the spread between i b, the interest
rate for borrowers, and i s, the interest rate for savers. The IS schedule shows the equilibrium interest
rate for any assumed level of current income Y, and MP is the monetary policy reaction function (MP). Michael Woodford 35 function,
function, the upward shift in XS should result in both a decline in the policy interest
rate and a contraction of real activity.10
This prediction matches the consequences observed, for example, when the
Carter administration imposed credit controls in the second quarter of 1980. This
policy was followed by a contraction in real GDP at a rate of minus 8 percent per
year in that quarter, while the federal funds rate also fell from a level over 17 percent
per annum in April to only 9 percent by July 1980. The effects of a policy tightening
of this kind cannot be understood as a shift of the MP curve (or LM curve) in a
conventional IS–MP (or IS–L...
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