mishkin ppt ch21

8/19/2019 Mishkin PPT Ch21

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Chapter 21

Monetary andFiscal Policy in

the ISLM Model


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Factors that Shift the ISCurve

• A change in autonomous factors that isunrelated to the interest rate

– Changes in autonomous consumer expenditure

– Changes in planned investment spendingunrelated to the interest rate

– Changes in government spending

– Changes in taxes– Changes in net exports unrelated to the

interest rate


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FIGURE 1 Shift in the IS Curve


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Factors that Shift the LMCurve

• Changes in the money supply

• Autonomous changes in money demand


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FIGURE 2 Shift in the LM Curve from anIncrease in the Money Supply


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FIGURE Shift in the LM CurveWhen Money Demand Increases


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Response to a Chan!e inMonetary Policy

• An increase in the money supply creates anexcess supply of money

• The interest rate declines

• Investment spending and net exports rise

• Aggregate demand rises

• Aggregate output rises

• The excess supply of money is eliminated• Aggregate output is positively related to the

money supply



FIGURE " esponse of Aggregate !utput andthe Interest ate to an Increase in the MoneySupply



Response to a Chan!e inFiscal Policy

• An increase in government spending raisesaggregate demand directly" a decrease intaxes ma#es more income availa$le for

spending

• The increase in aggregate demand causeaggregate output to rise

• A higher level of aggregate output increasesthe demand for money


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Response to a Chan!e inFiscal Policy #cont$d%

• The excess demand for money pushes theinterest rate higher

• The rise in the interest rate eliminates theexcess demand for money

• Aggregate output and the interest rate arepositively related to government spending

and negatively related to taxes



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FIGURE & esponse of Aggregate !utput andthe Interest ate to an %xpansionary &iscal 'olicy



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Monetary versus Fiscal Policy

• Complete cro(ding out

– %xpansionary fiscal policy does not lead to a risein output

– Increased government spending increases theinterest rate and )cro(ds out* investmentspending and net exports

• The less interest+sensitive money demand is,

the more effective monetary policy isrelative to fiscal policy



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Su''ary (a)le 1 %ffects from &actorsThat Shift the IS and LM Curves



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FIGURE * %ffectiveness of Monetary and &iscal'olicy When Money Demand Is -naffected $y theInterest ate


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(ar!etin! Ms versus InterestRates

• If the IS curve is more unsta$le .uncertain/than the 0M curve, a Ms target is prefera$le

• If the 0M curve is more unsta$le than the IScurve, an interest+rate target is preferred


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FIGURE + Money Supply and Interest+ateTargets When the IS Curve Is -nsta$le and theLM Curve Is Sta$le


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FIGURE , Money Supply and Interest+ateTargets When the LM Curve Is -nsta$le and the IS Curve Is Sta$le


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ISLM Model in the Lon! Run

• 1atural rate level of output .Y n/

– ate of output at (hich the price level has no tendencyto change

• -sing real values, so (hen the price level changes,the IS curve does not change

• The 0M curve is affected $y the price level

– As the price level rises, the 2uantity of money in real

terms falls, and the 0M curve shifts to the left until itreaches Y n .long+run monetary neutrality/

• 1either monetary or fiscal policy affects output inthe long run


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FIGURE - ISLM Model in the 0ongun


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FIGURE 1. Deriving the AggregateDemand Curve


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/erivin! the 0!!re!ate/e'and Curve

• Aggregate demand curve3 relationship$et(een the price level and 2uantity ofaggregate output for (hich the goods

mar#et and mar#et for money are ine2uili$rium

• As the price level increases, output falls4


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FIGURE 11 Shift in the Aggregate DemandCurve Caused $y a Shift in the IS Curve


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FIGURE 12 Shift in the Aggregate DemandCurve Caused $y a Shift in the LM Curve

mishkin ppt ch21

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