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Macro in Action

Review last week Another case study or 2 The open economy: Introduction What determines NX?. Macro in Action. LM 2. r. LM 1. r 2. r 1. IS. Y 1. Y 2. Y. Monetary policy: UK decrease in M.  M < 0 shifts the LM curve inward. 2. …causing the interest rate to rise.

sigourney-wyatt
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Macro in Action

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  1. Review last week Another case study or 2 The open economy: Introduction What determines NX? Macro in Action

  2. LM2 r LM1 r2 r 1 IS Y1 Y2 Y Monetary policy: UK decrease in M • M < 0 shifts the LM curve inward 2. …causing the interest rate to rise 3. …which decreases investment, causing output & income to fall.

  3. LM r r2 r1 IS2 IS1 Y1 Y2 Y 2. 1. 3. Brazil: increase in government purchases • IS curve shifts right causing output & income to rise. 2. This raises money demand, causing the interest rate to rise… 3. …which reduces investment, so the final increase in Y

  4. Interaction between monetary & fiscal policy • Model: Monetary & fiscal policy variables (M, G, and T) are exogenous. • Real world: Monetary policymakers may adjust Min response to changes in fiscal policy, or vice versa. • Such interaction may alter the impact of the original policy change.

  5. The Fed’s response to expansionary fiscal policy • 2001 U.S. recession • Bush cut T & increased G. • Possible Fed responses: 1.hold M constant 2.hold r constant 3.hold Y constant • In each case, the effects of the Gare different:

  6. LM1 r r2 r1 IS2 IS1 Y1 Y2 Y Response 1: Hold M constant Higher G and lower T, the IS curve shifts right. If Fed holds M constant, then LM curve doesn’t shift. Results:

  7. LM1 r LM2 IS2 IS1 Y3 Y1 Y2 Y Response 2: Hold r constant Higher G and lower T, the IS curve shifts right. To keep r constant, Fed increases Mto shift LM curve right. r2 r1 Results: Accommodating monetary policy. (In fact, the Fed actively cut r, as we discussed.)

  8. LM2 LM1 r r3 r1 IS2 IS1 Y1 Y2 Y Response 3: Hold Y constant Higher G and lower T, the IS curve shifts right. To keep Y constant, Fed reduces Mto shift LM curve left. r2 Results: Offsetting monetary policy

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