IS-LM MODEL The Economics of Money, Banking, and Financial Markets7th

Frederic S. Mishkin

J

what is IS-LM Model?

The Economics of Money, Banking, and

Financial Markets7th

• Economics Crystal ball.

• Tool for deeper understanding Government policy & GDP movements.

• John Hicks 1937.

The Economics of Money, Banking, and

Financial Markets7th

Determination of Aggregate Output.

› Keynesian recognitions:

› Y=Yad ƒ(C+I+G+NX).

› Keynesian analysis simplification.

- Fixed price level.

- Planned investment (known value).

- Gradually assessment addition.

The Economics of Money, Banking, and

Financial Markets7th

Determination of Aggregate Output.

› Equilibrium and Keynesian cross diagram.

The Economics of Money, Banking, and

Financial Markets7th

Determination of Aggregate Output.

›Do not forget:

- Up ward slopping (MPC).

- Multiplier affect.

- What if NX added (100$).

The Economics of Money, Banking, and

Financial Markets7th

Equilibrium in good market (driving IS curve).

› interest rate & planned investment.- Fund deficit.

- Fund surplus.

› Interest rate & net export.

› Interest rate & aggregate out-put.

The Economics of Money, Banking, and

Financial Markets7th

Equilibrium in good market (driving IS curve).

The Economics of Money, Banking, and

Financial Markets7th

Equilibrium in good market (driving IS curve).

The Economics of Money, Banking, and

Financial Markets7th

What is IS curve tell us?

› Good market clearance.

› Equilibrium level of out-put, given interest rate.

- Good market excess supply.

- Good market excess demand.

› Note: no unique out-put level.

The Economics of Money, Banking, and

Financial Markets7th

Equilibrium in money market (driving LM curve).

› Equilibrium condition:

M.D = M.S

› Main building blocks:

- Liquidity preferences theory.

Money demand determents:

• Interest rate.

• income.

The Economics of Money, Banking, and

Financial Markets7th

Equilibrium in money market (driving LM curve).

The Economics of Money, Banking, and

Financial Markets7th

What is LM curve tell us?

› Money market clearance.

› Equilibrium level of interest rate, given level of

out- put.

- Excess money supply.

- Excess money demand.

› Note: no unique interest rate.

The Economics of Money, Banking, and

Financial Markets7th

IS-LM determination aggregate out-put and

interest rate.

› Equilibrium in both

markets(IS-LM curves

intersection)

› Market forces to ward

General Equilibrium.

The Economics of Money, Banking, and

Financial Markets7th

Factors causes IS curve to shift.

› Change in:

- Autonomous consumer expenditure.

- Investment spending (unrelated to interest rate).

- Net export (unrelated to interest rate).

- Government spending or taxes.

The Economics of Money, Banking, and

Financial Markets7th

Factors causes IS curve to shift.

The Economics of Money, Banking, and

Financial Markets7th

Factors causes IM curve to shift.

› Change in Money supply.

The Economics of Money, Banking, and

Financial Markets7th

Factors causes IM curve to shift.

› Change in Autonomous Money demand.

The Economics of Money, Banking, and

Financial Markets7th

Change in equilibrium level, interest rate and

aggregate out-put.

› Response to change in fiscal policy.

› Response to change in monetary policy.

The Economics of Money, Banking, and

Financial Markets7th

Monetary policy VS Fiscal policy

› Solving high unemployment:

- Using fiscal policy.

- Using monetary policy.

› Conclusion.

The Economics of Money, Banking, and

Financial Markets7th

Monetary policy VS Fiscal policy

› Stable IS curve.

- Targeting interest rate.

- Targeting money supply.

The Economics of Money, Banking, and

Financial Markets7th

Monetary policy VS Fiscal policy

› Stable LM curve.

- Interest rate targeting.

- Money supply targeting.

The Economics of Money, Banking, and

Financial Markets7th

IS-LM model in long run.

› Response to money supply.

› Response to government spending.

The Economics of Money, Banking, and

Financial Markets7th

Driving aggregate demand curve.

The Economics of Money, Banking, and

Financial Markets7th

Factors shift Aggregate demand curve.

› Shift in IS curve (is curve factors).

The Economics of Money, Banking, and

Financial Markets7th

Factors shift Aggregate demand curve.

› Shifts in LM curve.

The Economics of Money, Banking, and

Financial Markets7th

Mathematics on board

- Multiplayer affect.

- Solving IS-LM equations.