Chapter 3. IS-LM model

Question 1

Walras’ law

Answer 1

IF the money market is in equilibrium the bond market will be as well

Question 2

Interest rate control and money supply control )

Answer 2

Interest rate control (quieren un “i” y para eso mueven la money supply linea) and money supply control (income increases entonces la curva se mueve y el i sube)

Summary:
Summary:
* Above the LM curve: Excess supply on the money market
. Below the LM curve: Excess demand on the money market
On the LM curve: Equilibrium on the money market

Question 3

Fiscal and monetary policy

Answer 3

Fiscal policy:
Fiscal policy is an economic policy instrument of the goverment, which tries to compensate for economic fluctuations by influencing taxes and government expenditure.

Monetary policy:
Monetary policy is the sum of all economic policy measures that a central bank takes to achieve its goals.

Question 4

All fiscal policies

Answer 4

Fiscal policy:
* Tax reduction / increase: income tax, value added tax
* Higher / lower transfer payments: unemployment benefit
* Higher / lower government spending: infrastructure, education
Expansionary fiscal policy:
G 1 and/or TI
Contractionary fiscal policy:
G 1 and/or T 1
Note:
Changes in G and T affect the IS-Curve, not the LM-Curve.

Question 5

Fiscal policy mechanisms

Answer 5

Expansionary fiscal policy
G sube, Z sube, Y sube, Y sube, Md sube, Ms sube e i unchanged
result: gdp ha subido

controversial bc
-crowding out
-value- for money
-time lag
-multiplier causes leakages
-Ricardian equivalence

contractionary fiscal policy:
T sube, Yd baja, C baja, Z baja, Y (PRODUCTION) baja, Y income baja mucho x multiplier
md baja money supply baja e i unchanged

Question 6

Monetary policy mechanisims

Answer 6

Monetary Policy in IS-LM Model
Expansionary montary policy:
A reduction in the interest rate or an increase in the money supply shifts the IM curve downwards.

Contractionary monctary policy:
An increase in the interest rate or a reduction in the money supply shifts the IM curve upwards

Note:
Monctary policy docs not shift the IS curve.

Espansionary monetary. policy in the IS-LM model
Ms sube i baja, I sube, Z sube, Y production and income sube (este ultimo quito por multiplier effect)
Md sube and money supply sube

Potential criticism:
* Does a loose monetary policy generate inflation?
Liquidity trap
Credibility of the central bank (e.g. Greenspan put, moral hazard)
* Effects on the exchange rate
The liquidity trap is a situation in which an increase in the money supply has no lowering effect on the interest rate.