Reconciling the Models

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Presentation transcript:

Reconciling the Models Liquidity Preference Model of the Interest Rate AD-AS Model Loanable Funds Model of the Interest Rate LRAS SRAS2 MS1 MS2 SRAS1 S1 Agg. Price Level (PL) Interest Rate (r) Interest Rate (r) PL3 S2 PL2 r r Here’s the story line… In the short-run: ↑MS , ↓r, ↑I, ↑Real GDP, ↑S In the long-run: ↑MS causes nominal wages to ↑; therefore ↓SRAS , the resulting ↑PL, ↑MD, which ↑r The resulting ↓ in Real GDP, ↓S, which ↑r in the loanable funds market. PL1 r1 MD2 r1 MD1 AD2 D AD1 M1 M2 Q1 Q2 Y1 Y2 Quantity of money Quantity of loanable funds Real GDP (Y)