IS-LM: Further analysis

EC 235 | Fall 2023

Materials

Required readings:

Blanchard, ch. 5.

Prologue

After setting up the IS and LM schedules and their interaction, we move on to analyzing the effects of economic policy on the goods and money markets.

Monetary influences

We begin by looking at the money market.

More specifically, how does monetary policy affect the level of output (income) and the interest rate?

Let us consider an increase in the money supply (M^S).

Real influences

Now, let us look at the goods market.

More specifically, how does fiscal policy affect the level of output (income) and the interest rate?

Let us consider two cases:

An increase in Government expenditures (ΔG > 0);
An increase in Net Taxes (ΔT > 0).

Policy effectiveness

How effective can fiscal and monetary policies be?

In other words, what will be the size of the effects on income (Y) and on the interest rate (i) of a given change in the policy variable?

In short, the effectiveness of each policy will depend on the slopes of the IS and LM schedules.

Policy effectiveness

In summary…