ECON 282: Applying the IS-LM Model Flashcards
An increase in government purchases…
- IS curve shifts by (1/(1-MPC))x(change in G) causing output and income to rise
- This raises money demand, causing the interest rate to rise
- Which reduces investment, so the final increase in Y is smaller than (1/(1-MPC))x(change in G)
A tax cut effect on IS-LM model
-Cosumers save (1-MPC) of the tax cut, so the initial boost in spending is smaller for change in T than for a equal change in G
Monetary policy: An increase in M
-An increase in M greater than 0 shifts the LM curve down (right)
-interest rate falls
-investment increase, causing output and income to rise
The BoC response to (change in G) that is greater than 0
-If Canada government increases G
BoC response:
-Hold M constant
-Hold r constant
-Hold Y constant
Hold M constant
-If BoC holds M constant, then LM curve doesn’t shift.
Hold r constant
-BoC increases M to shift LM right
Hold Y constant
BoC reduces M shifting LM left
IS SHOCKS
exogenous changes in the demand for goods and services
example: stock market boom or crash, change in C
LM SHOCKS
exogenous changes in the demand for money
examples: wave of credit card fraud increases demand for money
-more ATMS reduce money demand
Overnight rate
the interest rate banks charge one another on overnight loans
-short term
why does the BoC target interest rates instead of the money supply
- they are easier to measure than the money supply
- the BoC might believe that LM shocks are more prevalent than IS shocks. If so, targeting the interest rate stabilises income better than targeting the money supply
IS-LM and Aggregate demand
A change in P would shift LM and therefore affect Y
-the AD curve captures this relationship between P and Y
The SR and LR effects of an IS shock
A negative IS shock shifts IS and AD left, causing Y to fall
