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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