Economics 302 Sec 001 Intermediate Macroeconomic Theory and Policy Spring 2011 2 16 2011 Instructor Prof Menzie Chinn UW Madison Outline Deriving the IS LM Multipliers M ltipliers and policy polic efficacy efficac Graphical depiction of policy efficacy 5 1 Deriving the IS Relation D i i the Deriving th IS Curve C Figure 5 2 The Derivation of the IS Curve An increase in the interest rate decreases the demand for goods at any level of output leading to a decrease in the equilibrium level of output 3 of 33 5 2 Deriving the LM Relation D i i the Deriving th LM Curve C An increase in income leads at a given interest rate to an increase in the demand for money Given the money supply this increase in the demand for The Derivation of the money lleads d to an iincrease iin the h equilibrium ilib i iinterest rate LM Curve Figure 5 4 4 of 33 Multipliers and Policy Efficacy A multiplier is a parameter which summarizes the change in one variable for a one unit change in another typically exogenous variable variable As the model changes changes the multiplier for fiscal policy changes Solving for Multipliers in general For Fiscal Policy Monetary Policy Notice this is a new multiplier the change in real GDP for a one unit change in the price deflated money stock or real real money stock stock for short short Critical to understand how monetary policy li works k Fiscal LM steep vs flat i Fiscal IS steep p vs flat i Monetary LM flat vs steep i Monetary IS steep vs flat i The Zero Interest Bound 7 6 Ten year ear Treasury bill 5 Fed Funds 4 3 Three month Treasuryy bill 2 1 0 00 01 02 03 04 05 06 07 08 09 10 Monetary Policy in a Liquidity Trap Fiscal Policy in a Liquidity Trap
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