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21 Cards in this Set
- Front
- Back
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True or False:
Fiscal Policy is less effective at adjusting the economy than monetary policy. |
False!
Fiscal policy is more effective than monetary policy because it produces a more immediate change. |
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When government spending increases, what happens in the IS-LM model
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1. Planned Expenditure increases, stimulating output Y.
2. The increase in output Y increases the demand for real money balances at every point, but price level is fixed so interest rates (r) increase. 3. The increase in interest rates (r) partially offsets the expansionary effect of the increase in government spending. 4. Thus, the increase in Y is smaller in the IS-LM model than it would be in the KC model due to crowding out. 5. LM is fixed, so IS shifts right by ΔG / (1-MPC) |
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In the IS-LM model, what happens when the money supply is increased?
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1. Money Supply (M/P) increases.
2. Since M/P increases, interest rates (r) decrease due to the theory of liquidity preference. 3. output (y) increases because planned expenditure (PE) is stimulated. |
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What does IS-LM show about the effect of monetary policy on income?
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Monetary policy affects income by changing interest rates.
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True or False;
Fiscal and monetary policy are independent of each other. |
False!
Fiscal and Monetary policy are not independent of each other. Policy makers generally know what their counterparts are doing. |
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How does the economy respond to a tax increase?
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How the economy responds to a tax increase depends on how the Fed responds.
a. If the Fed holds the money supply constant, LM curve stays the same and IS shifts left. This hike leads to a recession. b. If the Fed holds interest rates constant, the tax increase shifts the IS curve left and the LM curve shifts left as well. If the economy is in a recession, this action deepens the recession. c. If the Fed holds income constant, then the tax increase shifts IS left and LM shifts right. |
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What is the source of shocks to the IS-LM model?
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Exogenous variables changing.
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True or False:
If policy makers do their jobs properly, shocks should lead to huge fluctuations. |
False!
If the policy makers are doing their jobs, then shocks shouldn't lead to huge fluctuations. |
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When the Fed announces changes, it's usually to interest rates and not the monetary supply. How does the Fed change money supply through interest rates?
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The Fed changes the federal funds rate - the rate at which banks borrow money from each other.
After a change in the rate is announced, bond traders are instructed to conduct open-market operations needed to change the money supply curve and shift the LM curve so that the pre-determined equilibrium interest rate is met. |
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The AD curve shows the relationship between what two elements of macroeconomics?
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1. Price Level (P)
2. National Income |
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Related to the IS-LM model, what happens to the AD curve when there is a shift other than P?
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AD curve shifts!
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When there is a change in P, how does the AD curve change?
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There is no actual change in the AD curve, just movement along the AD curve.
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What is the IS-LM model designed for?
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The short term, when prices are fixed.
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What is the key difference between the Keynesian model and the classical model?
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In the classical model, prices are flexible. In the Keynesian model, prices are stuck.
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What are the two potential causes of the Great Depression?
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1. Contractionary shift in the IS curve --> the spending hypothesis. Fault is placed on an exogenous fall in spending on goods and services.
2. Shock to the LM curve --> the money hypothesis. Fault is placed on the Fed for allowing the money supply to fall by such a large amount. |
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What are the two issues with the money hypothesis as the cause of the Great Depression?
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1. The behavior of real money balances. Monetary policy leads to a contractionary shift in the LM curve only if real money balances fall. However, during the Great Depression real money balances rise slightly.
2. The behavior of interest rates. If a contractionary policy shift in the LM curve triggered the Great Depression, there would have been higher interest rates. However, nominal interest rates fell continuously during the Great Depression. |
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How much did the price level fall during the Great Depression?
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25%
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Pigou Effect
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When falling prices expand income.
Pigou pointed out that as prices fall and real money balances rise, consumers should feel wealthier and spend more. This increase in consume spending should cause an expansionary shift in the IS curve and lead to a higher income. STABILIZING EFFECT OF DEFLATION. |
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Debt-Deflation Theory
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Unanticipated changes in the price level redistribute the wealth between debtors and creditors. A fall in the price level raises the real amount of this debt - the amount of the purchasing power the debtor must pay the creditor. Creditors are enriched.
DESTABILIZING EFFECT OF DEFLATION. |
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How do expected changes in prices affect income?
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When there are expected changes in income, the IS-LM model becomes:
Y = C(Y-T) + I(i + Eπ) + G --> IS M/P = L(i, Y) --> LM Expected inflation enters as a variable and it is initially assumed to be 0. No one assumes inflation. If everyone expects the price level to fall, Eπ is negative, shifting the IS curve left and decreasing income. |
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When firms expect deflation, they become _________ to borrow money.
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reluctant
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