Extensions and Critiques of the IS-LM Model Flashcards
What are the main assumptions of the IS-LM model?
Fixed prices, short-run focus, and no international trade effects.
What are the limitations of the IS-LM model?
It ignores inflation, long-run price adjustments, and international trade.
How does the IS-LM model explain business cycles?
Through shifts in the IS and LM curves due to policy changes and external shocks.
What is a liquidity trap in the IS-LM model?
A situation where monetary policy becomes ineffective because interest rates are near zero
Why might fiscal policy be ineffective in the IS-LM model?
Due to crowding-out effects or high interest rate sensitivity.
How do open economy extensions modify the IS-LM model?
They incorporate exchange rates and balance of payments.
How does inflation affect the IS-LM model?
It requires an additional Phillips Curve analysis, as IS-LM assumes fixed prices.
What is the IS-LM model’s relevance today?
It is still useful for short-run policy analysis but has been expanded in modern macroeconomics.
How do New Keynesian economists extend the IS-LM model?
By incorporating expectations, price rigidity, and real-world financial constraints.
How do central banks use the IS-LM model?
To evaluate monetary policy’s effects on output and interest rates.
