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Deriving the LM Curve

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When the IS curve intersects the LM curve, both goods and financial markets ... An increase in taxes shifts the IS curve to the left, and leads to a decrease in ... – PowerPoint PPT presentation

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Title: Deriving the LM Curve


1
Deriving the LM Curve
Equilibrium in financial markets implies that an
increase in income leads to an increase in the
interest rate. The LM curve is upward-sloping.
  • If

then
2
Shifts of the LM Curve
  • An increase in money leads the LM curve to
    shift down.

3
Putting the IS and theLM Relations Together
  • The IS-LM Model
  • Equilibrium in the goods market implies that
    an increase in the interest rate leads to a
    decrease in output.
  • Equilibrium in financial markets implies
    that an increase in output leads to an increase
    in the interest rate.
  • When the IS curve intersects the LM curve,
    both goods and financial markets are in
    equilibrium.

4
The Effects of an Increase in Taxes
  • An increase in taxes shifts the IS curve to
    the left, and leads to a decrease in the
    equilibrium level of output and the equilibrium
    interest rate.

5
IS-LM Model Overview
  • The combination of monetary and fiscal polices is
    known as the monetary-fiscal policy mix, or
    simply, the policy mix.

6
Nominal and Real Interest Rates,and the IS-LM
Model
  • When deciding how much investment to undertake,
    firms care about real interest rates. Then, the
    IS relation must read
  • The interest rate directly affected by monetary
    policythe one that enters the LM relationis the
    nominal interest rate, then

The real interest rate is
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