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Chapter 23
Monetary and Fiscal Policy
in the ISLM Model
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Factors that Shift the IS Curve
•
A change in autonomous factors that is unrelated to
the interest rate
–
Changes in autonomous consumer expenditure
–
Changes in planned investment spending unrelated to the
interest rate
–
Changes in government spending
–
Changes in taxes
–
Changes in net exports unrelated to the
interest rate
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supply of money
•
The interest rate declines
•
Investment spending and net exports rise
•
Aggregate demand rises
•
Aggregate output rises
•
The excess supply of money is eliminated
•
Aggregate output is positively related to the money
supply
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Response of Aggregate Output and Interest
Rate to an Increase in the Money Supply
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Response to a Change in Fiscal Policy I
•
An increase in government spending raises
aggregate demand directly; a decrease in taxes
makes more income available for spending
•

Effects from Factors That Shift the IS and LM
Curves
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Effectiveness of Monetary Versus Fiscal Policy
•
How can policy makers decide which policies
(changing the money supply, changing
government spending, or taxes) to use if faced
with too much unemployment?
•
In practice, fiscal and monetary policies are
used together in the combination known as the
policy mix
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The Policy Mix and German Unification
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Monetary versus Fiscal Policy
•
Complete crowding out
–
Expansionary fiscal policy does not lead to a rise in

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Money Supply and Interest Rate Targets When
IS Curve is Unstable and LM Curve is Stable
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Money Supply and Interest Rate Targets When LM Curve is
Unstable and IS Curve is Stable
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The ISLM Model in the Long Run
•
Natural rate level of output (Y
n
)
–
Rate of output at which the price level has no tendency
to change
•
The IS curve is based on real values, so when the price
level changes, the IS curve does not change
•
The LM curve is affected by the price level
–

the aggregate demand curve to shift
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Shift in the Aggregate Demand Curve from a Shift in
the IS Curve
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Shift in the Aggregate Demand Curve from a Shift in
the LM Curve