Final equilibrium r 1 Y 1 Conclusion MS r and Y MS Y but only a smaller

Final equilibrium r 1 y 1 conclusion ms r and y ms y

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Final equilibrium: r 1 , Y 1 Conclusion: MS r and Y . MS Y (but only a smaller increase in Y) Monetary policy is less effective (has a small effect on Y) when money demand is interest-elastic. Since the MD is interest elastic, a small drop in interest rate is required to reequilibrate the money market after the increase in the money stock. As a consequence, I & Y increase by a smaller amount.
Monetary Policy Effectiveness & the Slope of the LM Curve (c) Completely interest-inelastic money demand r 1 LM 0 IS 0 LM 1 E’ E r Y 0 Y 1 Y r 0 Suppose that MS (expansionary MP) while P unchanged. MS LM curve shifts rightward. r (from r 0 to r 1 ) Y (from Y 0 to Y 1 ). Final equilibrium: r 1 , Y 1 Conclusion: MS r and Y . MS Y (a largest increase in Y) Monetary policy is most effective (has a largest effect on Y) when money demand is completely interest- inelastic. Since the MD is interest inelastic, a large drop in interest rate is required to reequilibrate the money market after the increase in the money stock. However, MD is not affected by r. The only way to reequilibrate the money market is to increase Y to Y 1 .
Monetary Policy Effectiveness & the Slope of the LM Curve (d) Completely interest-elastic money demand LM 0 IS 0 = LM 1 E r Y 0 = Y 1 Y r 0 Suppose that MS (expansionary MP) while P unchanged. MS LM curve shifts rightward (from LM 0 to LM 1 ). Final equilibrium: r 0 , Y 0 Conclusion: MS Y unchanged Conclusion: MS Y unchanged Monetary policy is most ineffective (has no effect on Y) when money demand is completely interest-elastic. Since the MD is completely interest elastic, an increase in the MS does not change the r (i.e. liquidity trap). As a consequence, I & Y will remain unchanged.
Fiscal Policy Effectiveness & the Slope of the LM Curve (a) Interest-elastic money demand r 1 LM IS 0 IS 1 E’ E r Y 0 Y 1 Y r 0 Suppose that G (expansionary FP) G IS curve shift to the right (from IS 0 to IS 1 ) Y (from Y 0 to Y 1 ) r (from r 0 to r 1 ) Final equilibrium: r 1 , Y 1 Conclusion: G Y Fiscal policy is effective (has a larger effect on Y) when money demand is interest-elastic.Since the MD is interest elastic, only a small rise in interest rate is required to reequilibrate the money market given the unchanged money stock. As a consequence, I & Y decline by a smaller amount (i.e. smaller C-O effect).Y 2 D
Fiscal Policy Effectiveness & the Slope of the LM Curve (b) Interest-inelastic money demand r 1 LM IS 0 IS 1 E’ E r Y 0 Y 1 Y r 0 Suppose that G (expansionary FP) G IS curve shift to the right (from IS 0 to IS 1 ) Y (from Y 0 to Y 1 ) r (from r 0 to r 1 ) Final equilibrium: r 1 , Y 1 Conclusion: G Y Fiscal policy is less effective (has a smaller effect on Y) when money demand is interest-inelastic.Since the MD is interest inelastic, a greater rise in interest rate is required to reequilibrate the money market given the unchanged money stock. As a consequence, I & Y decline by a greater amount (greater C-O effect). Y 2 D
Fiscal Policy Effectiveness & the Slope of the LM Curve (c) Completely interest-inelastic money demand r 1 LM IS 0 IS 1 E’ E r Y 0 =Y 1 Y r 0 Suppose that G (expansionary FP) G IS curve shift to the right (from IS 0 to IS 1 ) Y unchanged r (from r 0 to r 1 ) Final equilibrium: r 1 , Y 0 Conclusion: G Y unchanged Fiscal policy is completely not effective (has no effect on Y) when money demand is completely interest-inelastic.

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