The Derivation and Shift in IS and LM curves - Macro Economic Framework, Macroeconomics Video Lecture | Macro Economics - B Com

hello and welcome to this time we are
doing another is LM model diagram type
question for intermediate macro in this
question we're dealing with is n LM but
we're not dealing with the equations
we're just going to deal with the the
diagram portion and I'm going to kind of
skip over the intuition and we're going
to focus on when monetary policy and
fiscal policy change at the same time so
before this we've dealt with shifts and
eius curve shifts in the LM curve and
the effect of that on the rest of the
model the is LM model and we usually
have that you know when something shifts
like say the government spends more
money or the cut taxes or suppose a
central bank changes something with the
monetary with the money supply we've
kind of had this ceteris paribus unction
all else equal assumption so there's
that one change and everything else is
equal with this question we're going to
consider what happens when monetary
policy and fiscal policy change at the
same time so getting started what's the
first question here question asks
suppose that the government wants to
raise investment ba but keep output
constant in the is-lm model what makes a
monetary and fiscal policy will achieve
this goal so first off let's think about
raising investment so in our model so
far investments been a function of
interest rate so negative is invert
investment is negatively linked to the
interest rate that is to say when the
interest rate it's super super high the
cost of borrowing is high and so we
expect investment to be rather low firms
to borrow not as much money then when
compared to when the interest rate is
very very low implying that the cost of
borrowing is very low and so we'd expect
firms to invest borrow quite a bit and
so investment going up so investment
tends to be negatively linked to the
real exchange rate sorry negative linked
to the interest rate so if we wanted to
increase investment what we need to do
is somehow decrease the interest rate we
could do that if you decrease the
interest rate using our LM curve
if the central bank increases the money
supply that's going to shift out the LM
curve which is going to drive down the
interest rate which is going to increase
in investment so the first step how do
we raise investment well we can do is
get the central bank to expand the money
supply that's going to decrease the
interest rate and that's going to
increase investments however when we do
this when we shift the LM curve out like
this and reduce the interest rate what
we also find is that output increases
right so but in this policy mix the goal
is to keep output constant so what other
policy mix can we include in addition to
this monetary expansion to ensure that
interest rates stay down there for
investment up but keep output constant
well what we could do is the following
in addition to the shift atom curve we
could shift in the is curve there's two
ways we could have a shift inward of
that is curve we could either decrease
government spending or we get increased
taxes either one the is curve is going
to shift inward or to the left and then
given the increase in the money supply
given M is going up the LM curve is
going to shift out or to the right so
together what's going to happen is when
we start off at this equilibrium you
know is curve sub 1 LM curve someone has
an intersection here with this interest
rate and this output if we increase the
money supply and shift out the LM curve
and decrease the is curve shifted inward
I'm using one of these policy mixes if
we change shift those curves in such a
way we we can get them to reach this new
equilibrium with a real interest rate at
our start to and keeping output constant
how much exactly should we increase the
money supply and how much exactly should
we either decrease in government
spending or increase in taxes or some
combination the two that's going to
depend on the economy you actually doing
but there's theoretically possible that
these two could be shifted in such a
a that the interest rate goes down and
therefore investment increases and we
keep up with constant and how you do
that well it's going to be some
combination of an expansionary monetary
policy and a contractionary fiscal
policy it's left that part be asked the
following in the early 1980s the US
government cut taxes and ran a budget
deficit or the Fed pursued a tight
monetary policy what effect should this
policy mix half so first off government
cut taxes and increased government
spending so what implication does that
have
well we found previously when we dealt
with the is curve decrease in taxes or
an increase in government spending and
or some combination of the two is going
to shift the is curve outward and I'll
show you how to draw that in a second
and then the second part of this the
monetary policy side the Fed pursued a
tight monetary policy
usually when we imply tight monetary
policy we're saying that the money
supply is either decreasing or the money
supply is growing at a slower rate than
it is otherwise so what happens when we
decrease the money supply well we have a
shift leftward or shift inward of the LM
curve so we were to combine those two
policy mixes together in the is-lm
diagram framework we get following so
we're starting off at this equilibrium
right here with our star sub 1 and y
star sub 1 so we start off with some
policy mix over here with our is Emma LM
curves intersecting at this point the
shift outward in the is curve from is f1
is m2 is reflecting the either
decreasing taxes and expansion and
government spending and then the second
part here is the shift inward of the LM
curve from L M sub 1 to homes of two so
what happens is the real interest rate
is definitely going to go up but
depending on the size of these shifts
we're not really sure what's going to
happen to output in fact I brought Y
stars on change but why
star is so given that the is curve
shifts out in the LM curve shifts inward
we definitely know that the real
interest rates going to go up and in
fact at that time in the 1980s the real
XD interest rate definitely went up act
on an aside story my grandma my great
grandma bought a CD back in the 80s and
she was getting like 15% interest is
insane she had it for like 20 years or
something anyway they had a very high
you just right around between ten and
fifteen percent and that part of the 80s
but what was the effect of those two
policy mixes the expansionary fiscal
policy in contractionary monetary policy
well within the is-lm model framework
the effect on output is uncertain
because it depends on the size of these
shifts if the this shift in the LM curve
is significantly bigger than the shift
in the is curve we expect output to be
in this range down here so we expect
output to be a bit lower
however the shift in the is curve
outward you know that decrease in tax is
increasing government spending if that
effect is seen differently bigger than
the monetary effect then we expect
output to be a bit higher than it was
before however whatever actually happens
the IMO framework doesn't quite tell us
so that's that hopefully was helpful let
me know if you have no questions thanks
enough good day bye