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Describe roles of banks and understand how the supply and demand of money
change with and without the presence of banks.
Explain factors that determine the demand for money and write down the
money demand function.
LEARNING OBJECTIVES
PREVIOUSLY
M
P
YL i
$YL(i )
M
P
YL i
Endogenous: Y and i
Y; Financial market
i
Start from the financial market (LM) first.
Goods market
Apply the IS-LM model to predict and explain effects of fiscal and monetary
policy, both separately and together.
Define and derive the grand equilibrium using the IS-LM Model.
LEARNING OBJECTIVES
Md
M/P
M/P
M/P
i1
i1
Supply
i2
Supply'
i2
An increase in money
causes the LM curve to
shift down.
Figure 5 - 5
LM
LM'
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11
an equilibrium
Figure 4 - 4
Ms'
THE LM CURVE
10
REFRESH
REFRESH
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15
13
14
THE LM CURVE
C(Y
T)
I goes down
Figure 5 - 2
The Derivation of the IS Curve
THE IS CURVE
i2 > i 1
equilibrium values
I (Y , i ) G
20
19
( , )
I (Y , i )
Equilibrium in the
Goods Market
Figure 5 - 1
Determining Output
C(Y
T)
I (Y , i ) G
Y = Z = C(Y T) + I + G.
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17
an equilibrium in the
an equilibrium in the
23
3)
2)
1)
True
False
Uncertain
24
REFRESH
Shifting up ZZ
Shifting down ZZ
Figure 5 - 3
22
21
T IS shifts in
Y and i I ?
An increase in taxes shifts the IS curve to the left and leads to a decrease in the
equilibrium level of output and the equilibrium interest rate.
Figure 5 - 7
Figure 5 - 7
28
27
C(Y
LM relation:
T)
M
P
YL(i )
I (Y , i ) G
25
Fiscal contraction
LM down (i at same Y)
LM up (i at same Y)
Expansion
Contraction
Ms affects IS or LM or both?
Fiscal expansion
26
POLICY APPLICATIONS
Figure 5 - 6
IS relation: Y
We will see the good side of austerity (saving) in longer time frames.
A monetary expansion
is more investment
friendly, i.e.,
increasing investment.
Y , i
The Effects of a
Monetary Expansion
Figure 5 - 8
MONETARY EXPANSION: MS
31
32
higher I
higher demand
I ?)
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29
lower money
Lower i
Lower Y
Austerity
fiscal contraction, cutting spending and increasing
taxes, so budget deficit (G-T) .
Problem
Fiscal Contraction: Good or Bad for Greece and for the Euro?
36
35
5)
4)
3)
2)
1)
REFRESH
lower i @
offsetting some
higher investment I
Up
Down
Monetary contraction
Down
Up
Down
Up
Up
Down
Movement
in Output
I )
Monetary expansion
IS shifts in (left)
Decrease in money
Fiscal contraction
None
None
Increase in money
None
Left
Decrease in spending
None
None
None
Shift of LM
Fiscal expansion
Right
Increase in spending
Left
Right
Decrease in taxes
Shift of IS
Increase in taxes
Table 5-1
POLICY SHOCKS
33
Up
Down
Down
Up
Up
Down
34
Movement in
Interest Rate
Higher Y (income)
decline in i
At point C, demand for goods < > supply for goods ???
MONETARY EXPANSION: MS
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39
T , G , (G-T)
38 of 33
37
Outcome 1
Outcome 2
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43
42
41
48
47
Outcome 3
46
45
51
52
49
50
Ch2 Appendix
Textbook Chap. 5
Assigned reading:
ANSWER
56
55
1)
2)
3)
4)
5)
QUESTION
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53