W3P3 - Notebook LM Flashcards
What does the ISLM model combine?
The goods market and the money market
On an ISLM graph, what is on the horizontal and vertical axes?
Income is on the horizontal axis and the nominal interest rate is on the vertical axis.
What does the IS curve represent in the ISLM model?
All the equilibria in the goods market.
What does the LM curve represent in the ISLM model?
All the equilibria in the money market.
What does the intersection of the IS and LM curves represent?
General equilibrium, where both the goods and money markets are in equilibrium.
What does a point to the left of the IS curve indicate?
Excess demand in the goods market.
What does a point to the left of the LM curve indicate?
Excess supply in the money market.
What happens when the money supply increases in the ISLM model?
The LM curve shifts to the right, interest rates initially decrease, and income increases. However, the increase in income also increases money demand which pushes interest rates back up, leading to a new equilibrium.
What happens when government spending increases in the ISLM model?
The IS curve shifts to the right, increasing both income and interest rates. The increase in interest rates reduces private investment, partially offsetting the initial increase in aggregate expenditure.
What is the “crowding out” effect?
An increase in government spending increases interest rates, which lowers private investment.
How does the ISLM model differ from the Keynesian cross model (or changing cost model)?
The ISLM model is a general equilibrium model that considers both the goods and money markets. The Keynesian cross model is a partial equilibrium model that assumes interest rates are fixed.
What happens to the LM curve when the central bank targets a specific interest rate?
The LM curve becomes a horizontal line at the target interest rate.
What is the Taylor rule?
A monetary response function that describes how a central bank sets nominal interest rates based on the level of output and inflation.
According to the Taylor rule, when should a central bank increase interest rates?
When income is above its long-term trend and/or inflation is above its target.
What is the TR schedule?
An upward sloping curve that graphically represents the Taylor rule. It shows that as income increases, interest rates should also increase.
