Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Fiscal multiplier wikipedia , lookup
Fear of floating wikipedia , lookup
Ragnar Nurkse's balanced growth theory wikipedia , lookup
Modern Monetary Theory wikipedia , lookup
Quantitative easing wikipedia , lookup
Monetary policy wikipedia , lookup
Business cycle wikipedia , lookup
Exchange rate wikipedia , lookup
Helicopter money wikipedia , lookup
Austrian business cycle theory wikipedia , lookup
Intermediate Macroeconomics – Lecture Note #4 Dr. Todd R. Yarbrough IV. The IS-LM Framework Our Stylized Facts so far: Output (Y) is determined in equilibrium in the goods market, the so-called Keynesian Cross, and the money market. The goods market essentially determines how much stuff gets made and purchased by consumers (C), businesses (I), and the government spending (G). The money market determines the nominal interest rate (i) in our economic system at the equilibrium of the Real MS ) and Money Demand (M d = Y × L(i)). Money Supply ( P 1. The IS Curve (Keynesian Cross Set-up) Let’s bring back the goods market equilibrium from Lecture 1: Y Z, Y Z 00 Y 00 =Z 00 Z0 Z Y 0 = Z0 Y =Z c0 − c1 T + I¯00 + G c0 − c1 T + I¯0 + G c0 − c1 T + I¯ + G 0 Y Y0 Y 00 Y Let’s assume that what is going on above is just that interest rates have been falling. As a result more investment is occurring in the goods market. More stuff is being bought and sold. This moves us along the Y curve to a higher level of output. First we move from Y to Y’ because we went from I to I’. We then go from Y’ to Y”, because we go from I’ to I”. Again, both of these moves occur because interest rates are falling, for whatever reason. [PANEL A] This tells us that in the goods market, Output (Y) and the nominal interest rate (i) are negatively correlated. We derive the IS Curve from this behavior (on the next page). [PANEL B] In this graph you should see the upward shift in Demand (Z) that occurs because of successive increases in Investment (I) which themselves occurred because of successive decreases in Nominal Interest Rate (i). [PANEL C] The IS Curve will shift when there is a change in Autonomous Spending ((C-T) + I + G) that arises from anything but interest rate changes. If for example the government increases spending, the IS curve will shift to the right. On the other hand, if the government were to raise taxes, then the IS Curve would shift to the left. 1 Y Z, Y (A) Z 00 Z0 Z 0 Y0 Y Y 00 Y i (B) i i0 i00 IS 0 Y0 Y 00 Y Y i (C) i IS− IS IS+ 0 Y− Y Y+ 2 Y 2. The LM Curve There is something confounding about the analysis derived in the previous section. Most notably, that output is negatively correlated with interest rates. In one way it makes perfect sense, as interest rates fall, the incentive to borrow rises among consumers, producers, and the government. For example, it is often argued that the government should take advantage of low interest rates and take care of infrastructure projects during such a time period. Such an argument is pretty solid, when you consider the work will most likely be required due to depreciation... but I digress. One thing however should confound you... As interest rates are falling, the incentive to hold cash rises. Meaning, we expect folks to save less during periods of low interest rates, as reserves don’t pay much and they themselves are trying to take advantage of the low rates and spend money, not save it. [PANEL D] Such behavior should result in the Money Demand (M d ) curve shifting upward, putting UPWARD pressure on interest rates, all else equal. [PANEL E] In other words, when it comes to the Money Market, we expect interest rates and output to be positively correlated. Let’s recall our Money Market graph from Lecture 3: i Ms i (E) LM iup iup (D) i∗ i∗ M D+ idown idown MD M D− 0 M Y− 0 M Y Y+ Y This is a pretty straightforward story. Money Demand = Y × L(i). So, as output (Y) rises putting downward pressure on interest rates in the good market, Money Demand also rises putting upward pressure on interest rates. You can think about this just like prices in a normal goods market. As prices rise, suppliers want to supply more and consumers want to buy less, and as prices fall, suppliers want to supply less and consumers want to buy more. This friction creates our equilibrium condition at a market price. In a similar way, the goods market (IS Curve) is putting downward pressure on interest rates as the economy grows, while the money market (LM Curve) is putting upward pressure on interest rates as the economy grows. The only thing that shifts the LM Curve, for now, is central bank policy changes. Increases in the Money Supply and targeting lower interest rates (expansionary money policy) shift the LM Curve to the right, while decreases in the Money Supply and targeting higher interest rates (contractionary monetary policy). i LM − LM LM + i 0 Y−Y Y+ 3 Y 3. Equilibrium in IS-LM We economists love our equilibriums, don’t we? Well, the IS-LM equilibrium is a bit special. i LM i∗ IS 0 Y Y The equilibrium nominal interest rate (i∗ ) clears both the goods market and the money market in equilibrium. If the interest rate is above equilibrium, we have surplus demand for money relative to consumption [too little borrowing]. If the interest rate is below equilibrium, we have a shortage of demand for money relative to consumption [too much borrowing]. So, equilibrium here sets a nominal interest rate at an equilibrium level of potential output, with all demand for borrowing equaling the supply of borrowing, and all demand for goods equaling the supply of goods. This means that shifts in either the IS or LM curve, all else equal, will lead to changes in the market clearing interest rate in both the goods and money markets. [PANEL F] Shift to the right of the IS curve causes an increase in the nominal interest rate, all else equal. Shift to the left of the IS curve causes a reduction of the nominal interest rate, all else equal. [PANEL G] Shift to the right of the LM curve causes a reduction in the nominal interest rate, all else equal. Shift to the left of the LM curve causes an increase in the nominal interest rate, all else equal. i i (F) LM − LM LM LM + i+ i i− i+ i i− IS− 0 Y− Y Y+ (G) IS IS+ IS 0 Y 4 Y− Y Y+ Y