ISLM model and comparative effectiveness of the fiscal and monetary policy.

ISLM model and comparative effectiveness of the fiscal and monetary policy.

ISLM model is a model which combines goods and money markets. ISLM model consists of two curves – IS and LM.

IS curve shows all the various combinations of r and Y at which equilibrium in goods’ markets exists. (I=S).

Elasticity of IS curve. It depends on:

- the responsiveness of I and S to changes in r (the more they respond, the bigger will be vertical shift in the I and S curves thus the bigger will be the effect on Y=> the more will be the IS curve.

- The size of multiplier and mps ana mpc: the higher mult. coef.=> the flatter saving function=>the bigger will be effect on Y=> the more elastic will be IS curve.

Shifts of IS curve depends on:

- changes in I and S independently on changes in r

LM curve shows all the various combinations of r and Y at which equilibrium in money market exists. (Ms=L)

Elasticity of LM curve depends on:

- the responsiveness of L to changes in Y (the greater the mpc, the more will the transactions demand for money increase as Y rises=> the more the L curve shifts to the right. Hence the more will the equil r rise and the steeper will be the LM curve).

- The responsiveness of L to changes in r (the more the L responds to a change in r, the flatter will be the L curve=>the less the equil r change for any given horizontal shift in the L curve=> the more elasyic LM curve will be; elasticity of LM curve depends on elasticity of L curve).

Shift of LM curve depends on:

- changes in liquidity preference of money demand and Ms independently on changes in Y.

Equilibrium:

The IS curve shows all combinations of r and Y at which the goods market is in equil. The LM curve shows all the combinations of r any Y at which the money market is in equil. Both markets will be in equil where the curves intersect.

Changes in equilibrium:

1. the influence of increase of Ms on both goods’ and money market:

when Ms rises=> incr in I,C=> general incr in Y, but the incr in Y leads to incr in liquidity preference, as a result r rises too.

Conclusion: goods’ market smooth out fluctuations in the money markets.

2. increase in G:

if Y rises=>L will oncrease, when L increase=> r rises, but incr in r influences on I and W. In our case I falls=> Y falls

Conclusion: money market smooths out the fluctuations in the goods market. Decr in Y due to participation of money market is called crowding out effect.

Assumptions:

Keyn Monet

1. LM curve is elastic 1.LM curve is inel,

cause L curve is elastic. as L curve is inel.

2. IS curve is inelastic. 2. IS curve is elastic,

r is the main determinant

of I.

Assumptions	Keynesian:	Monetary:
Basic assumptions Effect of expansionary fiscal policy Effect of expansionary monetary policy	1)LM is relatively elastic 2)IS is relatively inelastic Fiscal policy is effective Monetary policy is ineffective	1)LM is relatively inelastic 2)IS is relatively is elastic Fiscal policy is ineffective Monetary policy is effective(leads to­AD®­P(Y-unchanged)

According to modern Keynesians it is possible to find compromise between fiscal and monetary policy because fiscal and monetary policy are most effective when they are applied simultaneously.It is possible to apply them at the same time as any change in money marlet leads to changes in goods market.

Дата добавления: 2015-08-29