ISLM model Flashcards
Define exchange rate.
The price of one unit of foreign currency in terms of domestic currency
What does the money demand curve look like?
Sloping downwards
What causes a shift in the money demand curve?
Changes in income
What is the another way to talk about the demand for money?
Liquidity
What are the two options for liquidity we talk about?
Holding bonds or money in your hands
Does holding bonds or money mean you demand less money?
Bonds
What does the money supply curve look like?
Vertical line
Draw the money supply and money demand curves.
Picture
Who controls money supply?
Central banks
Why is money supply deemed to be exogenous?
It is a policy action chosen by central banks so decided outside of the model.
What do central banks carry out to shift the money supply curve?
Open market operations
What is the formula for the rate of return of a bond?
(walue of the bond - what your buy it for)/ what you bought it for
Why can the rate of return of saving your money and bonds never be too far apart?
Because of one increases it causes the other one to increase also
What is the symbol for rate of return on a bond and of your savings?
iB, ID
What does CU stand for?
The amount of currency held by the public
What does CRES stand for?
The currency reserves held by central banks
What does M0 stand for?
Monetary base
What is M0 equal to?
CU + CRES
What does DEP stand for?
The amount of money held in someones account
What are the axis for the money supply and demand curves?
i and money
How do you derive the LM curve?
Draw the money supply and demand curve on one graph, then increase the income and shift the money demand curve, then trace this increase in interest rate and plot it against income to get the LM curve.
Draw a LM curve.
Picture
What is LM the locus of points for?
Of equilibrium in the different income and interest space
What are the axis for the LM curve?
Income and interest rate
What is the equation for money demand?
L = kY - hi
What is the equation for money supply?
M = Ḿ
How can you derive the equation for the LM curve?
sub L=M into the money demand function and rearrange to make i the subject
What is the equation for the LM curve?
i = -M/h + (k/h)Y
Define the LM curve.
The LM curve identifies combinations of income and the interest Arte for which the demand for money equals the money supply
What does IS curve stand for?
Investment and saving curve.
How can you derive the equation for the IS curve?
Y = AE,m then range to be i the subject
What is the equation for the is curve.
i = (Ī + g)/b - ((1-c)Y)/b
What slopes do the IS and LM curves have?
IS - negative
LM - positive
How would an increase in government expenditure affect the iS curve?
Shift it to the right
What does b stand for?
The sensitivity of investment to the interest rate
Draw the ISLM curve.
Picture
How do you derive the IS curve?
Draft the AE curve and then increase the interest rate to shift the curve upwards, trace the increase in income and plot it against the interest rate increase.
How do you find the government multiplier or the money multiplier?
Differentiate Y partially with respect to the corresponding variable
Name three reasons we demand money.
- ) Transactions
- ) Precautionary motive
- ) Speculative motive
What is meant by precautionary motive?
Want to have cash in your pockets to take advantage of unseen purchases
What is meant by speculative motive?
By holding cash you forego the rate of return of bonds, by holding bonds you forego the liquidate money.
Why does the interest act negatively on demand?
The higher the interest rate the less I am going to gold cash because of the possible return
Define monetary policy.
Monetary policy manipulates the money supply (or interest rate) to achieve policy goals (such as a rise in income)
Define fiscal policy.
Fiscal policy manipulates government spending and taxes to achieve policy goals (such as a rise in income)
What curves do monetary policies effect?
The LM curve
What curves of fiscal policies effect?
The IS curve
If the IS curve fluctuates due to shocks what is the effect of the central bank fixing money supply?
The movement in the IS causes the income to fluctuate also
If the IS curve fluctuates due to shocks what is the effect of the central bank fixing the interest rate?
The LM curve must move to the intersection of the fixed interest rate and the shifted IS curve causing the income to fluctuate a lot
If the LM curve fluctuates due to shocks what is the effect of the central bank fixing money supply?
The movement in the LM causes the income to fluctuate also
If the LM curve fluctuates due to shocks what is the effect of the central bank fixing the interest rate?
The equilibrium is at the fixed interest rate and the IS so there is no change in the income
What is an example of an open market operation?
Buying bonds