1 / 22

IS-LM Revisited

IS-LM Revisited. Simple Income Determination Properties of IS & LM Curves Equilibrium Output & Interest Rates Economic Policy. (1) Simple Income Determination * Eco 1002 * Goods Market (IS) * Exogenous Interest Rate & Prices * Endogenous Income (GDP) (2) IS-LM Model

Download Presentation

IS-LM Revisited

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. IS-LM Revisited Simple Income Determination Properties of IS & LM Curves Equilibrium Output & Interest Rates Economic Policy

  2. (1) Simple Income Determination * Eco 1002 * Goods Market (IS) * Exogenous Interest Rate & Prices * Endogenous Income (GDP) (2) IS-LM Model * Eco 2101 (Keynesian Short-Run) * (1) + Money Market * Endogenous Income & Interest Rate (Fixed P) • Endogenous Policy

  3. Simple Income Determination(Eco 1001) • Behavioral Assumptions: Consumption = C (y, r) y = disposable income = Y – T r = interest rate MPC = where 0 < Cy < 1 Investment = I(r) Government Purchases = G • Exogenous: r, P, Fiscal Policy: G, T • Endogenous: Y • Linear Examples

  4. Equilibrium: • Some Basic Results: (interest rates and GDP) (Gov. Spending Multiplier) (Tax Multiplier)

  5. IS-LM Model (Eco 2101) • Goods & Money Market Equilibrium • IS-LM Model Exogenous: P, Fiscal Policy: G, T Monetary Policy: Ms Endogenous: Y and r

  6. IS and the Goods Market • Goods Market Equilibrium: Y = C(y,r) + I(r) + G (IS equation) where y = Y – T = disposable income 0< Cy < 1 Ir < 0 G and T are exogenous policy variables

  7. Properties of IS curve: Slope*: Government spending multiplier: (shifts right) Tax Multiplier: (shifts left)

  8. LM and the Money Market • Real Money Demand = L(Y,r) • Money Market Equilibrium: Ms = P*L(Y,r) (LM equation) Ms is an exogenous policy variable.

  9. Properties of LM curve Slope*: Real Money Supply: (shifts right)

  10. The Simple IS-LM Model - (Y,r) which solves: (IS) (LM)

  11. Policy in IS-LM Model Exogenous: P Endogenous: Y, r Policy Variables: G, Ms, T • Fiscal Policy (1) Government Expenditures (dG) but less than 1/(1-Cy)!

  12. Crowding-out effect! • Effectiveness of G: If (IS Flat) or (LM verticle) then . (Complete crowding-out!) (2) Taxes (dT): dY/dT = ?, dr/dT = ?

  13. Monetary Policy (dMs):

  14. Effectiveness of monetary policy: If (IS vertical) or (LM flat) Then (Ineffective Monetary Policy)

  15. Liquidity Trap and Interest Rate Insensitivity • Great Depression YearURipr = i - p 1930 8.9 3.6 -2.6 6.2 1931 16.3 2.6 -10.1 12.7 1932 24.1 2.7 -9.3 12.0 1933 25.2 1.7 -2.2 3.4 1934 22.0 1.0 7.4 -6.6 1935 20.3 0.8 0.9 -0.1 1936 17.0 0.8 0.2 0.6

  16. 2008-09 Recession Jan 2007 – Jan 2010, Federal funds rate cut from 6% to 1%. i UR Jan 2007 5.25% 4.6% Jan 2008 3.94% 5% Jan 2009 0.15% 7.7% Jan 2010 0.12% 10%

  17. Business Cycles in IS-LM • Shocks to Consumer confidence (g): C = C(Y,r,g) where Cg > 0  dY*/dg > 0 dr*/dg > 0 • Shocks to money demand (s): L = L(y,r,s) where Ls> 0  dY*/ds < 0 dr*/ds > 0

  18. Endogenous Policy • Monetary/Fiscal Policy responds to economic conditions to achieve goal. Objective: dY = 0 (output stability) OR dr = 0 (interest rate stability) Exogenous: Policies - Ms or G, or T Shocks – g or s Endogenous: Policies - Ms or G, or T

  19. Example: An increase in G and Fed’s objective is to keep r constant (prevent crowding out). • Step 1: Set dr = 0 Step 2: Treat dY and dMs as endogenous, dG as exogenous. Step 3: Use Cramer’s Rule to solve for dY/dG and dMs/dG. Suppose instead Fed wanted to keep output stable (dY = 0). Find dr/dG and dMs/dG.

  20. Evaluation of Simple Keynesian IS-LM Models • Provided reasonable explanation of business cycles. • Guides policymakers on stabilizing economic fluctuations. • Can be applied easily to think about current events.

  21. Shortcomings • Criticisms of IS-LM Model: (1) Emphasis on aggregate demand. (2) Static Model. (3) Lack of solid microeconomic foundations. • Lucas Critique on Policy Evaluation • Examples: Consumption, Phillips Curve

  22. Modern Macro • Dynamics • Expectations (rational) • Microeconomic Foundations Most modern macro models (New Classical and New Keynesian) have these features.

More Related