1. chapter 23 Monetary and Fiscal Policy in the ISLM Model

2. Copyright © 2002 Pearson Education Canada Inc. 23- 2 Shift in the IS Curve 1.C  : at given i A, Y ad , Y   IS shifts right 2.Same reasoning when I , G , NX , T  Figure 23-1

3. Copyright © 2002 Pearson Education Canada Inc. 23- 3 Shift in the LM Curve from a Rise in M s 1.M s  : at given Y A, i  in panel (b) and (a)  LM shifts to the right Figure 23-2

4. Copyright © 2002 Pearson Education Canada Inc. 23- 4 Shift in the LM Curve from a Rise in M d 1.M d  : at given Y A, i  in panel (b) and (a)  LM shifts to the left Figure 23-3

5. Copyright © 2002 Pearson Education Canada Inc. 23- 5 Summary: Factors that Shift IS and LM Curves

6. Copyright © 2002 Pearson Education Canada Inc. 23- 6 Response to an Increase in M s 1.M s  : i , LM shifts right  Y  i  Figure 23-4

7. Copyright © 2002 Pearson Education Canada Inc. 23- 7 Response to Expansionary Fiscal Policy 1.G  or T  : Y ad , IS shifts right  Y  i  Figure 23-5

8. Copyright © 2002 Pearson Education Canada Inc. 23- 8 The Policy Mix and German Unification 1.Fiscal expansion led to right shift from IS, to IS 2 ; moved economy from 1 to 2; i  Y  2.Tight money policy led to left shift from LM to LM 2 ; moved economy to 3 3.Result: fast growth, high interest rates

9. Copyright © 2002 Pearson Education Canada Inc. 23- 9 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 Figure 23-7

10. Copyright © 2002 Pearson Education Canada Inc. 23- 10 M s vs. i Targets When IS Unstable 1.IS unstable: fluctuates from IS' to IS'' 2.i target at i*: Y fluctuates from Y I ' to Y I '' 3.M target, LM = LM*: Y fluctuates from Y M ' to Y M '' 4.Y fluctuation is less with M target Conclusion: If IS curve is more unstable than LM curve, M target is preferred Figure 23-8

11. Copyright © 2002 Pearson Education Canada Inc. 23- 11 M s 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 Y M ' to Y M '' 4.Y fluctuation is less with i target Conclusion: If LM curve is more unstable than IS curve, i target is preferred Figure 23-9

12. Copyright © 2002 Pearson Education Canada Inc. 23- 12 The ISLM Model in the Long Run Panel (a) 1.M s up, LM right to LM 2, go to point 2, i to i 2, Y to Y 2 2.Because Y 2 > Y n, P , M/P , LM back to LM 1, go back to point 1 Panel (b) 1.G , IS right to to IS 2, go to point 2 where i = i 2 and Y = Y 2 2.Because Y 2 > Y n, P , M/P , LM left to LM 2, go to point 2, i = i 2` and Y = Y n. Figure 23-10

13. Copyright © 2002 Pearson Education Canada Inc. 23- 13 Deriving AD Curve P , M/P , LM shifts in, Y  Points 1, 2, 3 Figure 23-11

14. Copyright © 2002 Pearson Education Canada Inc. 23- 14 Shift in AD from Shift in IS At given P A, IS shifts right: Y  in panel (b)  AD shifts right in panel (a) Figure 23-12

15. Copyright © 2002 Pearson Education Canada Inc. 23- 15 Shift in AD from Shift in LM At given P A, LM shifts right: Y  in panel (b)  AD shifts right in panel (a) Figure 23-13