chapter 24 monetary and fiscal policy in the islm model
Post on 19-Dec-2015
233 Views
Preview:
TRANSCRIPT
Chapter 24
Monetary and Fiscal Policy in the ISLM Model
© 2004 Pearson Addison-Wesley. All rights reserved 1-2
Shift in the IS Curve
1. C : at given iA, Yad , Y IS shifts right
2. Same reasoning when I , G , NX , T
© 2004 Pearson Addison-Wesley. All rights reserved 1-3
Shift in the LM Curve from a Rise in Ms
1. Ms : at given YA, i in panel (b) and (a) LM shifts to the right
© 2004 Pearson Addison-Wesley. All rights reserved 1-4
Shift in the LM Curve from a Rise in M d
1. M d : at given YA, i in panel (b) and (a) LM shifts to the left
© 2004 Pearson Addison-Wesley. All rights reserved 1-5
Response to an Increase in Ms
1. M s : i , LM shifts right Y i
© 2004 Pearson Addison-Wesley. All rights reserved 1-6
Response to Expansionary Fiscal Policy
1. G or T : Yad , IS shifts right Y i
© 2004 Pearson Addison-Wesley. All rights reserved 1-7
Summary: Factors that Shift IS and LM Curves
1-8
Effectiveness of Monetary and Fiscal Policy
1. M d is unrelated to i i , M d = M s at same Y LM vertical
2. Panel (a): G , IS shifts right i , Y stays same (complete crowding out)
3. Panel (b): M s , Y so M d , LM shifts right i Y Conclusion: Less interest sensitive is M d, more effective is monetary policy relative to fiscal policy
© 2004 Pearson Addison-Wesley. All rights reserved 1-9
Optimal Choice of Monetary Policy Instruments (Poole, QJE 1970)
Assume that random variables and have normal distribution and their means are 0 and variances and .
( ) ( )Y C Y T I i G
( , )M
L i YP
2 2
© 2004 Pearson Addison-Wesley. All rights reserved 1-10
Ms vs. i Targets When IS Unstable
1. IS unstable: fluctuates from IS' to IS''
2. i target at i*: Y fluctuates from YI' to YI''
3. M target, LM = LM*: Y fluctuates from YM' to YM''
4. Y fluctuation is less with M target
Conclusion: If IS curve is more unstable than LM curve, M target is preferred
© 2004 Pearson Addison-Wesley. All rights reserved 1-11
Ms vs. i Targets When LM Unstable
1. LM unstable: fluctuates from LM' to LM''
2. i target at i*: Y = Y*
3. M target: Y fluctuates from YM' to YM''
4. Y fluctuation is less with i target
Conclusion: If LM curve is more unstable than IS curve, i target is preferred
© 2004 Pearson Addison-Wesley. All rights reserved 1-12
The ISLM Model in the Long Run
Panel (a)1. Ms , LM right to LM2, go to point 2, i to i2, Y to Y2
2. Because Y2 > Yn, P , M/P , LM back to LM1, go back to point 1Panel (b)1. G , IS right to IS2, go to point 2 where i = i2 and Y = Y2
2. Because Y2 > Yn, P , M/P , LM left to LM2, go to point 2', i = i2` and Y = Yn.
© 2004 Pearson Addison-Wesley. All rights reserved 1-13
Deriving AD Curve
P , M/P , LM shifts in, Y Points 1, 2, 3
© 2004 Pearson Addison-Wesley. All rights reserved 1-14
Shift in AD from Shift in IS
At given PA, IS shifts right: Y in panel (b) AD shifts right in panel (a)
© 2004 Pearson Addison-Wesley. All rights reserved 1-15
Shift in AD from Shift in LM
At given PA, LM shifts right: Y in panel (b) AD shifts right in panel (a)
© 2004 Pearson Addison-Wesley. All rights reserved 1-16
Deriving the AD curve from IS-LM
• Combine these two equation by substituting di,
• Or ,
2( ) ( )
(1 )
d
d
i Y i
Y i Y i
dM ML dG C dT I dP
P PdYC L L I
( )dY idY C dY dT I di dG
2Y i
PdM MdPL dY L di
P
2( ) ( )
d
YY i
i i
L dYPdM MdPdY C dY dT I dG
P L L
© 2004 Pearson Addison-Wesley. All rights reserved 1-17
Deriving the AD curve from IS-LM
• The slope of AD (let dG = dT = dM = 0)
• Shift of AD caused by dG (let dP = dT = dM = 0)
• Shift of AD caused by dM (let dP = dT = dG = 0)
2
(1 )| 0dY i Y iAD
i
C L L IPMY IP
| 0(1 )
D
iAD
Y i Y i
LY
G C L L I
/| 0
(1 )D
iAD
Y i Y i
I PY
M C L L I
© 2004 Pearson Addison-Wesley. All rights reserved 1-18
Deriving the AD curve from IS-LM
• If there is liquidity trap:
• AD curve is vertical.
2
(1 )lim lim D
i i
Y i Y i
L L
i
C L L IPMY IP
top related