9-44Real Money Demand and Interest Rates•Because the real money demand depends on the level of real GDP, if the money stock is constant, the equilibrium nominal interest rate will vary whenever real GDP varies•When Y falls the liquidity preference will shift to the left and the interest rates fall.•When Y increases the liquidity preference will shift to the right and the interest rates increase.
9-45Figure 9.11 - From Money Demand to theLM CurveAs Y increases, the real money demand curve shifts up As Y increases, the real money demand curve shifts up The LM curve gives for each Y the nominal interest rate that brings the money market to equilibriumThe LM curve gives for each Y the nominal interest rate that brings the money market to equilibriumThis increases the equilibrium nominal interest rate.This increases the equilibrium nominal interest rate.
9-46The LM Curve•The LM curve shows the relationship between the level of real GDP and the equilibrium nominal interest rate that clears the money market•The LM curve slopes upward–at a higher level of real GDP, money demand is higher and therefore the equilibrium nominal interest rate is higher
9-47The LM Curve•The equation for the LM curve is•An increase in the money supply, or a decline in price level shift the LM curve to the right•An increase in real money demand L0 shifts the LM curve to the left)+r(×LL+LLP/M=YeYiY0π-
9-48Figure 9.12 –LM shift to right when M/P increases or L0 falls
The Slope of LM Curve
9-51Figure 9.13 - The IS-LM Diagram
9-52The IS-LM Framework•The equilibrium levels of real GDP and the interest rate occur at the point where the IS and LM curves intersect–the economy is in equilibrium in both the goods market and the money market
9-53IS-LM Equilibrium•Example (assume that πe is constant at 3% or 0.03)–IS curve: Y = $1,000 - $2,000r–LM curve: Y = $100 + $10,000(r+πe)3)0.0$10,000(r$100$2,000r-$1,000++=$12,000r$600=5%0.05r==billion$900Y=
9-54Figure 9.14 - IS-LM Equilibrium Example
9-55Figure 9.15 - Effect of a Positive IS Shock
9-56IS Shocks•Any change in economic policy or the economic environment that increases autonomous spending shifts the IS curve to the right–the new equilibrium will have a higher level of real GDP