Download ISLM: Part IV: Policy Tools (Fiscal and Monetary)

ISLM Analysis
Part IV: Policy Tools
(Fiscal and Monetary)
The Keynesian Framework
According to John Hicks and Alvin Hansen
Roger W. Garrison
2010
S
S
Seq
i
i
ieq
ieq
MT
MSPEC
MSPEC
MT
Y
LM
I
i
IS
Yeq Y
Y
Ieq
I
S+T
S
II
+G
S+T
i
I+G
G
II
+G
S+T
S
S+T
Y
i
I+G
G
I+G
bT
S+T
S+T
S = -a -+(1-b)T
(1-b) Y+ (1-b)Y
(1-b)(Y-T)
(1-b)T
- a - (1-b)T
Y
S+T
S+T
Y
i
I+G
I+G
S+T
S+T
(S+T)eq
i
i
ieq
ieq
MT
MSPEC
MSPEC
MT
Y
LM
I+G
i
IS
Yeq Y
Y
(I+G)eq
I+G
We focus on just two of the quadrants of ISLM
to show how a fiscal stimulus in the form of
increased government spending is weakened
by a countermovement in investment spending.
i
ieq
LM
i
IS
Yeq Y
(I+G)eq
I+G
Suppose
With
ISLMthe
analysis,
MPC inwe
Macrovia
can show
is 0.75,
that fiscal
implying
stimuli
a spending
don’t have
multiplier
the same
of 4.
strength
And
suppose
as they
thatdid
income
in the issimple
$1,200
Keynesian
below its modes.
full-employment
That’s because
level.
government
How
much additional
spendingspending
crowds out
would
investment
drive thespending.
economyAny
to full
such
employment
“crowding
out” offsets
a. inthe
themagnitude
simple Keynesian
of the stimulus
framework?
dollar-for dollar.
b. in the ISLM framework?
i
i
LM
IS 1200
880
I+G
IS’
Yfe
I+G’
300
I+G
Y
80
Crowding Out
Crowding out (ΔI) may amount to 80, in which case the net stimulus would
be only 220. And the actual increase in income would be 880.
1200
900
300
Y = C + I + G
Once we know the actually magnitude
of the crowding out, we can show how
it manifests itself even in the simple
Keynesian model.
300
Y = C + I + G
80
The
Theresult
reduction
is a net
of investment
increase inspending
I+G of 220.
in the amount of 80 accompanies the
government spending of 300.
880
660
220
Y = C + ( I + G)
The simple Keynesian multiplier applies to (ΔI + ΔG).
Can you identify
Suppose
we observe
the
a sharp increase
resulting
changesinin
the equilibrium
fetish-basedlevels
component
in
the economy’s
of the
demand for
monetary
sector?
money.
S+T
S+T
(S+T)eq
i
i
ieq
ieq
Y
LM
I+G
i
IS
MT
MSPEC
MSPEC
MT
Yeq Y
Y
(I+G)eq
I+G
Which
Can
you
of identify
the two the
sector-equilibrium
resulting
changes in
curves
the
equilibrium
shifts and
levels
in
which
in
the economy’s
direction does
real
it shift?
sector?
S+T
With would
How
the equation
adopting
of
the hard-drawn
exchange
in play, some
version
of
the transactions
of Keynes’s (S+T)eq
theory have
balances
areaffected
drawn into
the results? balances.
speculative
i
i
ieq
ieq
S+T
Y
LM
I+G
i
IS
MT
MSPEC
MSPEC
MT
Yeq Y
(I+G)eq
I+G
The
These
interest
transactions
rate would
have
balances
risenare
higher,
freedand
income
up as income
would have
spirals
fallen
downward.
farther.
Y
Are allpolicy
What
the behavioral
tool is
most appropriate
magnitudes
drivenfor
re-establishing
back
to their original
the
original interest rate
levels?
and level of income?
i
ieq
MT
S+T
S+T
(S+T)eq
I+G
Y
What
most i
i policy would
LM beLM
appropriate if prices, wages, and
the interest rate all responded to
ieq
surpluses
and shortages like
IS
your micoeconomics professor
suggested they do?
MSPEC
MSPEC
MT
Yeq Y
Y
(I+G)eq
I+G
No. The increased
Should the
policy
demand
for M
SPEC is
be expansionarybyora
accommodated
contractionary?
dollar-for-dollar
increase in supply.
ISLM Analysis
Part IV: Policy Tools
(Fiscal and Monetary)
The Keynesian Framework
According to John Hicks and Alvin Hansen
Roger W. Garrison
2008