Intermediate Macroeconomics
Lecture 8
The Money Market & LM Curve
The theory of liquidity preference
(,)
dM
L r YP?? ???
??
sMM
P P
?
?
?? ?
????
r
M/P
M
P
?
?
()Lr
The Money Market & LM Curve
Paul Volcker
To fight high inflation ? Tight money policy
(Oct,1979)
Y e a r I n f la t ion ( G D P de f la t or )
78 7.17
79 8.40
80 9.17
81 9.34
82 6.14
83 3.97
84 3.74
85 3.17
86 2.18
The Money Market & LM Curve
How does such a monetary tightening
influence interest rate?
It depends…
LR,Fisher effect,inflation↓ ? interest rate ↓
SR,Liquidity theory,M ↓ ? interest rate ↑
The Money Market & LM Curve
Income,money demand,& LM curve
r
M/P
M
P
?
?
(,1)L r Y
r2
r1 (,2)L r Y
r
Y Y1 Y2
LM
The Money Market & LM Curve
An algebraic example of LM curve
(,)M L r Y aY brP ? ? ?
0a ? 0b ?
1 MarY
b P b
??? ? ? ???
??
Short-Run Equilibrium
IS-LM Model
The intersection of IS and LM represents
simultaneous equilibrium in the market for goods and
services and in the market for real money balances at
a give price level
()E Y C Y T I G? ? ? ? ?
(,)M L r Y
P
?
IS
LM r
Y
Exercise
P254 4,
Consider the impact of an increase in thriftiness in the
Keynesian Cross,Suppose,where
is a parameter called autonomous consumption and
c is the marginal propensity to consumption,
a,What happens to equilibrium income when the
society becomes more thrifty (decline in )?
b,What happens to equilibrium savings?
c,Why do you suppose this result is called the
paradox of thrift?
()C C c Y T?? ? ? C?
C?
Answer
a,E
Y
?Y
1 ()E C c Y T I G
? ? ? ?? ? ? ? ?
2 ()E C c Y T I G
? ? ? ?? ? ? ? ?
Answer
b,Equilibrium savings would not be
affected,
Because in Keynesian Cross,S=I,
because I does not change,S would not
change,
Answer
c,In this case,the behavior of thriftiness does
decreases the consumption,However,it does not
increase the savings as what we would expect,That
is why it is called the paradox of thrift,
This happens because thriftiness only leads to a
decrease in income Y,Therefore,although C
decreases,with a lower Y,S does not change,
To individuals,thriftiness is usually considered as a
virtue,especially in the Eastern World,From the
perspective of Keynesian Cross,thriftiness is no good
at all,
Aggregate Demand II
Potential causes of fluctuations
(monetary & fiscal policies)
The Great Depression
Monetary & Fiscal Policies
Fiscal Policy
()E Y C Y T I G? ? ? ? ?
(,)M L r YP ?
1
GG I S
M PC
?? ? ? ?
?
1
T M P CT I S
M P C
? ? ?? ? ? ?
?
LM
IS
A
r
Y
B
C
Monetary & Fiscal Policies
The increase in Y in response to a fiacal
expansion is smaller in the IS-LM model
than in the Keynesian Cross,
A fiscal expansion raises the interest
rate and,crowds out” investment
Monetary & Fiscal Policies
Monetary Policy
Change in M shifts LM curve
()E Y C Y T I G? ? ? ? ?
(,)M L r YP ?
LM
IS
A
r
Y
Monetary & Fiscal Policies
Increase in money supply
?Lowers the interest rate
?Stimulates investment
?Expands the D for goods and services
This is called the
monetary transmission mechanism,
Monetary & Fiscal Policies
The interaction between 2 kinds of policies
e.g,the congress raises T to fight budget deficit
What effects would it have on the economy?
It depends…
Depends on how the Fed,responds,
Monetary & Fiscal Policies
1,Fed,holds the money supply constant
LM
IS
A
r
Y
Monetary & Fiscal Policies
2,Fed,wants to hold r constant
LM
IS
A
r
Y
Monetary & Fiscal Policies
3,Fed,wants to prevent the recession
LM
IS
A
r
Y
Monetary & Fiscal Policies
The impact of the change in fiscal policy
depends on the monetary policy
Shocks to IS-LM Model
Investor’s animal spirits
Consumer confidence
Demand for money
(confidence of the banking system)
The Great Depression
Please read the book！
If you have any question,come to me
or the T.A.s for help,or consult your
classmates ?
Lecture 8
The Money Market & LM Curve
The theory of liquidity preference
(,)
dM
L r YP?? ???
??
sMM
P P
?
?
?? ?
????
r
M/P
M
P
?
?
()Lr
The Money Market & LM Curve
Paul Volcker
To fight high inflation ? Tight money policy
(Oct,1979)
Y e a r I n f la t ion ( G D P de f la t or )
78 7.17
79 8.40
80 9.17
81 9.34
82 6.14
83 3.97
84 3.74
85 3.17
86 2.18
The Money Market & LM Curve
How does such a monetary tightening
influence interest rate?
It depends…
LR,Fisher effect,inflation↓ ? interest rate ↓
SR,Liquidity theory,M ↓ ? interest rate ↑
The Money Market & LM Curve
Income,money demand,& LM curve
r
M/P
M
P
?
?
(,1)L r Y
r2
r1 (,2)L r Y
r
Y Y1 Y2
LM
The Money Market & LM Curve
An algebraic example of LM curve
(,)M L r Y aY brP ? ? ?
0a ? 0b ?
1 MarY
b P b
??? ? ? ???
??
Short-Run Equilibrium
IS-LM Model
The intersection of IS and LM represents
simultaneous equilibrium in the market for goods and
services and in the market for real money balances at
a give price level
()E Y C Y T I G? ? ? ? ?
(,)M L r Y
P
?
IS
LM r
Y
Exercise
P254 4,
Consider the impact of an increase in thriftiness in the
Keynesian Cross,Suppose,where
is a parameter called autonomous consumption and
c is the marginal propensity to consumption,
a,What happens to equilibrium income when the
society becomes more thrifty (decline in )?
b,What happens to equilibrium savings?
c,Why do you suppose this result is called the
paradox of thrift?
()C C c Y T?? ? ? C?
C?
Answer
a,E
Y
?Y
1 ()E C c Y T I G
? ? ? ?? ? ? ? ?
2 ()E C c Y T I G
? ? ? ?? ? ? ? ?
Answer
b,Equilibrium savings would not be
affected,
Because in Keynesian Cross,S=I,
because I does not change,S would not
change,
Answer
c,In this case,the behavior of thriftiness does
decreases the consumption,However,it does not
increase the savings as what we would expect,That
is why it is called the paradox of thrift,
This happens because thriftiness only leads to a
decrease in income Y,Therefore,although C
decreases,with a lower Y,S does not change,
To individuals,thriftiness is usually considered as a
virtue,especially in the Eastern World,From the
perspective of Keynesian Cross,thriftiness is no good
at all,
Aggregate Demand II
Potential causes of fluctuations
(monetary & fiscal policies)
The Great Depression
Monetary & Fiscal Policies
Fiscal Policy
()E Y C Y T I G? ? ? ? ?
(,)M L r YP ?
1
GG I S
M PC
?? ? ? ?
?
1
T M P CT I S
M P C
? ? ?? ? ? ?
?
LM
IS
A
r
Y
B
C
Monetary & Fiscal Policies
The increase in Y in response to a fiacal
expansion is smaller in the IS-LM model
than in the Keynesian Cross,
A fiscal expansion raises the interest
rate and,crowds out” investment
Monetary & Fiscal Policies
Monetary Policy
Change in M shifts LM curve
()E Y C Y T I G? ? ? ? ?
(,)M L r YP ?
LM
IS
A
r
Y
Monetary & Fiscal Policies
Increase in money supply
?Lowers the interest rate
?Stimulates investment
?Expands the D for goods and services
This is called the
monetary transmission mechanism,
Monetary & Fiscal Policies
The interaction between 2 kinds of policies
e.g,the congress raises T to fight budget deficit
What effects would it have on the economy?
It depends…
Depends on how the Fed,responds,
Monetary & Fiscal Policies
1,Fed,holds the money supply constant
LM
IS
A
r
Y
Monetary & Fiscal Policies
2,Fed,wants to hold r constant
LM
IS
A
r
Y
Monetary & Fiscal Policies
3,Fed,wants to prevent the recession
LM
IS
A
r
Y
Monetary & Fiscal Policies
The impact of the change in fiscal policy
depends on the monetary policy
Shocks to IS-LM Model
Investor’s animal spirits
Consumer confidence
Demand for money
(confidence of the banking system)
The Great Depression
Please read the book！
If you have any question,come to me
or the T.A.s for help,or consult your
classmates ?
