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Unformatted text preview: of economic activity. The MP curve is drawn for a given
inflation rate. The arrow shows the consequence of an exogenous shift in the policy reaction function
that implies a lower interest rate for any given level of economic activity. 28 Journal of Economic Perspectives the
the LS curve down and to the right, as shown by the arrow. It should also reduce
the demand for loans, insofar as borrowers have more current income available
out of which to finance current spending needs or opportunities, in which case the
LD curve shifts down and to the left, as also shown in the figure. The vertical shift in
the LD curve is likely to be smaller than the vertical shift of the LS curve, as shown in
Figure 2A, if the expenditure of borrowers is more interest-elastic than the expenditure
ture of savers. The intersection of the grey curves shows the new equilibrium values,
i2 and L2.
Tracing out the equilibrium interest rate for any assumed level of current
income Y, one obtains the IS schedule plo...
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