Download Shifts of Aggregate Demand Curve

Chapter 23
Monetary and
Fiscal Policy in
the ISLM Model
© 2008 Pearson Education Canada
23.1
1. Factors that Shift the IS Curve
• A change in autonomous factors that is unrelated to
the interest rate
– Changes in (autonomous) consumer expenditure unrelated
to income: C
– Changes in (planned) investment spending unrelated to
the interest rate: I
– Changes in government spending: G
– Changes in taxes: T
– Changes in net exports: NX
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23.2
Summary: What shifts IS?
• IS(C+I+G+X-M; T)
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23.3
2. What Shifts LM Curve?
• Changes in the money supply: M
- Expansionary Monetary Policy shifts LM to the right
- Contractionary Monetary Policy shifts LM to the left
• Autonomous changes in money demand=
Shocks/Disturbances in Monetary Markets: u
-More Money Demand sends LM to the left
-Less Money Demand sends LM to the right
• Changes in the Price Level: P
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23.4
*Sum: What shift LM curve?
(MS/P, u)
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23.5
Example 1) Shift in the LM Curve from an
Increase in the Money Supply
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23.6
Example 2) Shift in the LM Curve from an
Increase in Money Demand
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23.7
The above case of an increased money demand
is highly relevant to the current financial crisis:
• Recall that Money Market and Bond Market
are closely related(substitutes)
An increase in demand for cash = decrease in
demand for financial assets such as bonds
• The LM curve shifts to the ‘left’
• The net impact on the Money Market is
equivalent to a decrease in Money Supply
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23.8
3. Combining IS and LM shift
What will happen to the equilibrium Y
and the equilibrium i if LM shifts?
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23.9
(1) Response to
a Change in Monetary Policy
• An increase in the money supply creates an excess
supply of money
-The interest rate declines
-Investment spending and net exports rise
- Y rises in the IS-LM.
-Aggregate demand side of National Income rises
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23.10
Response of National Income and Interest Rate to an Increase
in the Money Supply
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23.11
* Effects from Various Factors That Shift (the IS
and) LM Curves
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23.12
(3) Effectiveness of (Expansionary)
Monetary Policy on Interest Rate and Y
• With a normally shaped upward-sloping LM
curve and a variety shapes of IS curves:
• With a normally shaped IS and a speicial form
of LM curve:
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23.14
Monetary Policy
• The less interest-sensitive money demand is,
the more effective monetary policy is relative
to fiscal policy
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23.15
4. Long-Run IS-LM
1) Flexible Price Level in LR
So far, we have assumed that the Price Level is
fixed- it is justifiable in the Short-run
In the Long-run, the Price Level is flexible.
Thus, the LM curve adjusts itself so that the
equilibrium Y is equal to the full employment
national income(Yf)1)
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23.16
(2) Yn in the Long Run
• Full employment nantional income is called ‘Natural
rate level of output (Yn)’
– It is called ‘Full Employment National Income’ Yf as well
– Rate of output at which the price level has no tendency
to change
– Neither monetary nor fiscal policy affects output in
the long run
– It is affected by Capital, Labor, and Technology.
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23.17
(3) Which adjusts?
• The IS curve is based on real values, so when the
price level changes, the IS curve does not change
• The LM curve is affected by the price level
– As the price level rises, the quantity of money in real
terms falls, and the LM curve shifts to the left until it
reaches Yn (long-run monetary neutrality)
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23.18
(4) Illustration:
ISLM in the Long Run
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23.19
• This is the end of IS-LM model.
• The rest of chapter 23 serves as an
introduction of Chapter 24
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23.20
5. Ultimately, AS-AD Model
(1) AS and AD
• Aggregate Supply
Short-run AS
Long-run AS
• Aggregate Demand
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23.21
(1) AS Curve
• There are two AS curves: One is the Short-run AS curve, and the other
corresponds to Yf or Yn
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(2) AD
First, focus on
Deriving AD curve,
And then shifting AD
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23.23
(i) deriving the AD Curve by changing
Price Level
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23.24
(ii) Shifts of Aggregate Demand Curve
For a given price level
- change in C, I, G, NX,and/or T shifts IS curve
and then AD curve(illustrated in b)
- changes in M, u shifts LM curve and then AD
curve(illustrate in a)
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23.25
(a) Shift in the Aggregate Demand Curve from a Shift
in the LM Curve
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(b) Shift in the Aggregate Demand Curve from a Shift
in the IS Curve
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In sum, AD shifts due to
Δ in C, I, G, NX, T and M, u.
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(3) Equilibrium of AS-AD
• (i) Basic
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(ii) Changes to an increased MS
• In the short-run, Y rises.
• In the long-run, it depends on where the initial Y is compared to Yf.
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