Week 5 - Monetary and Fiscal Policy: The IS-MP Model

Question 1

How does Fiscal policy generally link to the IS-MP model

Answer 1

Changes in G will shift the IS schedule (fiscal policy)

Question 2

How does Monetary policy generally link to the IS-MP model

Answer 2

Changes in L = M/P will shift the MP schedule (monetary policy)

Question 3

What is Quantitative easing

Answer 3

A Monetary policy tool used by central banks to stimulate the economy, by increasing the money supply

Question 4

What is Quantitative tightening

Answer 4

A Monetary Policy tool used by central banks to prevent overheating the economy, by decreasing the money supply

Question 5

What is Monetary financing

Answer 5

When the Central bank creates money to finance a government deficit

Question 6

What are Open market operations

Answer 6

The buying and selling of government securities in the open market to either increase or decrease the amount of reserves available in banks

Question 7

What affects the slope of the MP curve

Answer 7

The slope of the MP curve is determined by the responsiveness of money demand to change in output
- The shift in 𝐿𝐿 when output changes
determines the corresponding change in
interest rates.
* If money demand is highly responsive to a
change in output, interest rates change a
lot (the MP curve is steep)
* If money demand is not very responsive to
a change in output, interest rates change
very little (the MP curve is flat)

Question 8

Describe Fiscal policy with a flat MP curve

Answer 8

Money demand is not very responsive to changes in output
Fiscal policy is ineffective
- A bond-financed increase in government spending shifts the 𝐼𝑆 schedule to 𝐼𝑆’
- Little change in r, large change in Y
- Minimal crowding out of private spending