chapter 23 Monetary and Fiscal Policy in the ISLM Model
Copyright © 2002 Pearson Education Canada Inc Shift in the IS Curve 1.C : at given i A, Y ad , Y IS shifts right 2.Same reasoning when I , G , NX , T Figure 23-1
Copyright © 2002 Pearson Education Canada Inc Shift in the LM Curve from a Rise in M s 1.M s : at given Y A, i in panel (b) and (a) LM shifts to the right Figure 23-2
Copyright © 2002 Pearson Education Canada Inc Shift in the LM Curve from a Rise in M d 1.M d : at given Y A, i in panel (b) and (a) LM shifts to the left Figure 23-3
Copyright © 2002 Pearson Education Canada Inc Summary: Factors that Shift IS and LM Curves
Copyright © 2002 Pearson Education Canada Inc Response to an Increase in M s 1.M s : i , LM shifts right Y i Figure 23-4
Copyright © 2002 Pearson Education Canada Inc Response to Expansionary Fiscal Policy 1.G or T : Y ad , IS shifts right Y i Figure 23-5
Copyright © 2002 Pearson Education Canada Inc The Policy Mix and German Unification 1.Fiscal expansion led to right shift from IS, to IS 2 ; moved economy from 1 to 2; i Y 2.Tight money policy led to left shift from LM to LM 2 ; moved economy to 3 3.Result: fast growth, high interest rates
Copyright © 2002 Pearson Education Canada Inc Effectiveness of Monetary and Fiscal Policy 1.M d is unrelated to i i , M d = M s at same Y LM vertical 2.Panel (a): G , IS shifts right i , Y stays same (complete crowding out) 3.Panel (b): M s , Y so M d , LM shifts right i Y Conclusion: Less interest sensitive is M d, more effective is monetary policy relative to fiscal policy Figure 23-7
Copyright © 2002 Pearson Education Canada Inc M s vs. i Targets When IS Unstable 1.IS unstable: fluctuates from IS' to IS'' 2.i target at i*: Y fluctuates from Y I ' to Y I '' 3.M target, LM = LM*: Y fluctuates from Y M ' to Y M '' 4.Y fluctuation is less with M target Conclusion: If IS curve is more unstable than LM curve, M target is preferred Figure 23-8
Copyright © 2002 Pearson Education Canada Inc M s vs. i Targets When LM Unstable 1.LM unstable: fluctuates from LM' to LM'' 2.i target at i*: Y = Y* 3.M target: Y fluctuates from Y M ' to Y M '' 4.Y fluctuation is less with i target Conclusion: If LM curve is more unstable than IS curve, i target is preferred Figure 23-9
Copyright © 2002 Pearson Education Canada Inc The ISLM Model in the Long Run Panel (a) 1.M s up, LM right to LM 2, go to point 2, i to i 2, Y to Y 2 2.Because Y 2 > Y n, P , M/P , LM back to LM 1, go back to point 1 Panel (b) 1.G , IS right to to IS 2, go to point 2 where i = i 2 and Y = Y 2 2.Because Y 2 > Y n, P , M/P , LM left to LM 2, go to point 2, i = i 2` and Y = Y n. Figure 23-10
Copyright © 2002 Pearson Education Canada Inc Deriving AD Curve P , M/P , LM shifts in, Y Points 1, 2, 3 Figure 23-11
Copyright © 2002 Pearson Education Canada Inc Shift in AD from Shift in IS At given P A, IS shifts right: Y in panel (b) AD shifts right in panel (a) Figure 23-12
Copyright © 2002 Pearson Education Canada Inc Shift in AD from Shift in LM At given P A, LM shifts right: Y in panel (b) AD shifts right in panel (a) Figure 23-13