ECON 3010 Intermediate Macroeconomics Chapter 12

Transcription

1 ECON 3010 Intermediate Macroeconomics Chapter 12 Aggregate Demand II: Applying the IS-LM Model

2 Equilibrium in the IS LM model The IS curve represents equilibrium in the goods market. = C ( T ) + I ( r ) + G The LM curve represents money market equilibrium. r 1 r LM M P = L( r, ) The intersection determines the unique combination of and r that satisfies equilibrium in both markets. 1 IS

3 Policy analysis with the IS-LM model = C ( T ) + I ( r ) + G r LM M P = L( r, ) r 1 We can use the IS-LM model to analyze the effects of fiscal policy: G and/or T 1 IS monetary policy: M

4 An increase in government purchases 1. IS curve shifts right 1 by G 1 MPC causing output & income to rise. 2. This raises money demand, causing the interest rate to rise 3. which reduces investment, 1 so the final increase in 3. 1 is smaller than G 1 MPC 2. r 2 r 1 r 1. 2 LM IS 2 IS 1

5 A tax cut Consumers save (1 MPC) of the tax cut, so the initial boost in spending is smaller for T than for an equal G and the IS curve shifts by MPC 1 MPC T so the effects on r and are smaller for T than for an equal G. 2. r 2 r 1 r LM IS 2 IS 1

6 Monetary policy: An increase in M 1. M > 0 shifts the LM curve down (or to the right) 2. causing the interest rate to fall r 1 r 2 r LM 1 LM 2 3. which increases investment, causing output & income to rise. 1 2 IS

7 Shocks in the IS-LM model IS shocks: exogenous changes in the demand for goods & services. Examples: stock market boom or crash change in households wealth C change in business or consumer confidence I and/or C

8 Shocks in the IS-LM model LM shocks: exogenous changes in the demand for money. Examples: A wave of credit card fraud increases demand for money. More ATMs or the Internet reduce money demand.

9 The SR and LR effects of an IS shock A negative IS shock shifts IS and AD left, causing to fall. r P P 1 LRAS LM(P 1 ) IS 1 IS 2 LRAS SRAS 1 AD 1 AD 2

10 The SR and LR effects of an IS shock r LRAS LM(P 1 ) In the new short-run equilibrium, < P P 1 LRAS IS 2 IS 1 SRAS 1 AD 1 AD 2

11 The SR and LR effects of an IS shock r LRAS LM(P 1 ) In the new short-run equilibrium, < Over time, P gradually falls, causing: SRAS to move down M/P to increase, which causes LM to move down P P 1 LRAS IS 2 IS 1 SRAS 1 AD 1 AD 2

12 The SR and LR effects of an IS shock r LRAS LM(P 1 ) LM(P 2 ) Over time, P gradually falls, causing: SRAS to move down M/P to increase, which causes LM to move down P P 1 P 2 IS 1 IS 2 LRAS SRAS 1 SRAS 2 AD 1 AD 2

13 The SR and LR effects of an IS shock r LRAS LM(P 1 ) LM(P 2 ) This process continues until economy reaches a long-run equilibrium with = P LRAS IS 2 IS 1 P 1 SRAS 1 P 2 SRAS 2 AD 1 AD 2

14 CASE STUD The financial crisis & recession 2009: Real GDP fell, unemployment approached 10% Important factors in the crisis: early 2000s Federal Reserve interest rate policy subprime mortgage crisis bursting of house price bubble, rising foreclosures falling stock prices failing financial institutions declining consumer confidence, drop in spending on consumer durables and investment goods

15 Interest rates and house prices 9 8 Federal Funds rate 30-year mortgage rate 190 Case-Shiller 20-city composite house price index interest rate (%) House price index, 2000 =

16 Change in U.S. house price index and rate of new foreclosures, Percent change in house prices (from 4 quarters earlier) 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% US house price index New foreclosures New foreclosure starts (% of total mortgages) -6%

17 House price change and new foreclosures, 2006:Q3 2009:Q1 20% New foreclosures, % of all mortgages 18% 16% 14% 12% 10% 8% 6% 4% 2% Nevada Florida Illinois Michigan Ohio California Arizona Rhode Island New Jersey Georgia Colorado Texas Hawaii Oregon Alaska 0% -40% -30% -20% -10% 0% 10% 20% Cumulative change in house price index S. Dakota Wyoming N. Dakota

18 U.S. bank failures by year, Number of bank failures

19 140% 120% 100% 80% 60% 40% 20% 0% -20% -40% -60% Major U.S. stock indexes (% change from 52 weeks earlier) DJIA S&P 500 NASDAQ -80% 12/6/1999 8/13/2000 4/21/ /28/2001 9/5/2002 5/14/2003 1/20/2004 9/27/2004 6/5/2005 2/11/ /20/2006 6/28/2007 3/5/ /11/2008 7/20/2009

20 20% Consumer sentiment and growth in consumer durables and investment spending % change from four quarters earlier 15% 10% 5% 0% -5% -10% -15% -20% Durables Investment UM Consumer Sentiment Index -25% Consumer Sentiment Index, 1966 = 100

21 Real GDP growth and unemployment % change from 4 quarters earlier Real GDP growth rate (left scale) Unemployment rate (right scale) % of labor force