Macroeconomics Chapter 5: IS-LM Model Overview

Fiscal policy focuses on government spending and taxation while monetary policy works with interest rates and money supply.

A fiscal expansion increases government spending or reduces taxes, stimulating the economy by boosting aggregate demand.

A monetary expansion lowers interest rates and increases the money supply, stimulating the economy by boosting investment and consumption.

A fiscal consolidation reduces government spending or increases taxes, aiming to curb government debt and deficit.

A monetary contraction increases interest rates and reduces the money supply, aimed at controlling inflation.

A fiscal squeeze is a fiscal policy that aims to reduce the government's deficit and debt.

A policy mix involves coordinating both fiscal and monetary policy to achieve desired economic outcomes.

The short-run effects of a policy change may differ from its long-run impacts.

The relationship between the interest rate and the equilibrium level of output in the goods market.

Refers to planned spending on goods and services in the economy, including consumption, investment, government spending, and net exports.

The line in the goods market model that represents the equilibrium condition where aggregate demand (Z) equals output (Y).

The level of output where planned spending (Z) equals actual output (Y), representing the equilibrium point in the goods market.

The relationship between the interest rate and the equilibrium level of output in the goods market, where investment is treated as a function of output and the interest rate.

A component of aggregate demand, representing spending by firms on new capital goods, such as factories, equipment, and housing.

A component of aggregate demand, representing spending by households on goods and services, influenced by factors like disposable income and consumer confidence.

The cost of borrowing money, often expressed as an annual percentage rate.

An increase in taxes causes a leftward shift of the IS curve, leading to a lower equilibrium level of output.

A decrease in interest rates shifts the LM curve downwards, resulting in higher equilibrium output. This is because lower interest rates encourage borrowing and investment.

A combined use of monetary and fiscal policies to achieve economic goals. This involves adjusting both interest rates and government spending to stimulate or restrain economic activity.

The combination of expansionary fiscal policy (increasing government spending or cutting taxes) and expansionary monetary policy (lowering interest rates) to boost economic activity.

The 2001 recession in the United States was triggered by a decline in investment demand, leading to a decrease in economic activity. The recession period lasted between March 2001 and December 2001.

The Federal Reserve responded to the 2001 recession by aggressively lowering the target federal funds rate from 6.5% in January to 2% by the end of 2001.

The U.S. government implemented tax cuts in 2001 and 2002 budgets to stimulate economic activity during the recession.

The IS curve shows the relationship between the equilibrium level of output in the goods market and the interest rate. It is downward sloping because an increase in the interest rate reduces investment spending, decreasing the demand for goods and therefore reducing the equilibrium level of output.

The IS curve shifts to the left when factors decrease the demand for goods, such as an increase in taxes or a decrease in government spending. It shifts to the right when factors increase the demand for goods, such as a decrease in taxes or an increase in government spending.

The LM curve shows the relationship between the equilibrium level of real money supply and the interest rate, in the financial markets. It is typically drawn as a horizontal line because the central bank sets the interest rate and adjusts the money supply.

The IS-LM model is a macroeconomic model that combines the goods market (IS curve) with the financial markets (LM curve). The model is used to analyze the equilibrium level of output and the interest rate in the economy.

The intersection of the IS and LM curves represents a point where both the goods market and financial markets are in equilibrium. This equilibrium point determines the equilibrium level of output and the interest rate.

Policy changes or exogenous variables can shift either the IS or LM curve, impacting the equilibrium level of output and the interest rate. For example, an increase in government spending (fiscal policy) would shift the IS curve right, leading to higher output and a potentially higher interest rate.

To analyze the effects of changes in policy or exogenous variables on the economy using the IS-LM model, one needs to determine which curve(s) are affected and how they shift. Then, analyze the new equilibrium point and how it translates to changes in output and interest rates.

The model allows for studying the interaction between the goods market, affected by investment and saving, and the financial market, controlled by monetary policy. It aids in understanding how fiscal and monetary policies influence overall economic activity.