Money Demand Money demand (demand for real balances) is influenced : positively by income

Money Demand Money demand (demand for real balances) is influenced : positively by income negatively by interest rates.

Money Demand Money demand (demand for real balances) is influenced : positively by income negatively by interest rates. That is: + - m d = f ( y, i)

Money Demand: inverse relation between interest rate and real balances m1dm1d Real balances r

Money Demand: inverse relation between interest rate and real balances m1dm1d Real balances r

Equilibrium in the money market m1dm1d M 1 s (P 1 ) Real balances r r1r1

Increase in Demand for Money m1dm1d M 1 s (P 1 ) Real balances r2r2 m2dm2d r1r1

LM Curve m1dm1d M 1 s (P 1 ) Real balances r income m2dm2d

LM Curve m1dm1d M 1 s (P 1 ) Real balances r income r1r1 r2r2

LM Curve m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 )

LM Curve m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 )

LM Curve: expansionary monetary policy m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 )

LM Curve: expansionary monetary policy m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 ) M 1 s (P 2 )

LM Curve: expansionary monetary policy m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 ) M 1 s (P 2 )

LM Curve: expansionary monetary policy m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 ) M 1 s (P 2 )

AD in a Keynesian System m1dm1d M 1 s (P 1 ) Real balances r income r1r1 m2dm2d r2r2 LM 1 (P 1 ) M 1 s (P 2 ) LM 2 (P 2 )

Prices and the LM Prices can change the position of LM the same way changes in the stock of money supply would. A decrease in price level is exactly the same as an increase in the money supply. Both will shift the LM curve to the right. An expansionary monetary policy.

AD in a Keynesian System AD Real income LM (P 1 ) LM (P 2 ) IS r1r1 r2r2 P1P1 P2P2 y1y1 y2y2 a b a’ b’

AD in a Keynesian System AD Real income LM (P 1 ) LM (P 2 ) IS r1r1 r2r2 P1P1 P2P2 y1y1 y2y2 a b a’ b’ IS’ AD’ G or I or X

Vertical LM If money demand is completely independent of the interest rates, then it will be vertical and LM will be vertical. In this case, fiscal policy in completely ineffective.

Vertical LM If money demand is completely independent of the interest rates, then it will be vertical and LM will be vertical. In this case, fiscal policy in completely ineffective. This is the case of complete crowding out.

Vertical LM If money demand is completely independent of the interest rates, then it will be vertical and Lm will be vertical. In this case, fiscal policy in completely ineffective. In this case fiscal policy does not have any effect on the AD. Only monetary policy would be effective

Vertical LM IS IS’’ IS’ LM

Expansionary Monetary Policy and AD in a Keynesian System AD Real income LM (P 1 ) LM (P 2 ) IS r1r1 r2r2 P1P1 P2P2 y1y1 y2y2 a b a’ b’ LM (M 2 P 1 ) AD’

Expansionary Monetary Policy and AD in a Keynesian System (Vertical LM) Unlike Fiscal Policy monetary policy is very potent IS lm 1 lm 2 Lm 1 ’ Lm 2 ’ AD’ AD P1P1 P2P2 r1r1 r2r2

Keynesian AS N W N1N1 N2 L1dL1d

Keynesian AS f(N) N W y N N1N1 N2

Keynesian AS f(N) N W y N N1N1 N2

Keynesian AS f(N) N W y N 45  y y P y N1N1 N2 P1P1 y1y1 AS

Keynesian AS f(N) N W y N 45  y y P y N1N1 N2 P1P1 y1y1 AS

Keynesian AS f(N) N W y N 45  y y P y N1N1 N2 P2P2 P1P1 y1y1 y2y2

Keynesian AS f(N) N W y N 45  y y P y N1N1 N2 P2P2 P1P1 y1y1 y2y2 AS

Keynesian AS: Technological advance f(N) N W y N 45  y y P y N1N1 N2 P2P2 P1P1 y1y1 y2y2 AS AS’