Week 5 - Monetary and Fiscal Policy: The IS-MP Model Flashcards
(17 cards)
How does Fiscal policy generally link to the IS-MP model
Changes in G will shift the IS schedule (fiscal policy)
How does Monetary policy generally link to the IS-MP model
Changes in L = M/P will shift the MP schedule (monetary policy)
What is Quantitative easing
A Monetary policy tool used by central banks to stimulate the economy, by increasing the money supply
What is Quantitative tightening
A Monetary Policy tool used by central banks to prevent overheating the economy, by decreasing the money supply
What is Monetary financing
When the Central bank creates money to finance a government deficit
What are Open market operations
The buying and selling of government securities in the open market to either increase or decrease the amount of reserves available in banks
What affects the slope of the MP curve
The slope of the MP curve is determined by the responsiveness of money demand to a change in output
- The shift in πΏπΏ 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)
Describe Fiscal policy with a flat MP curve
Money demand is not very responsive to changes in output
Fiscal policy is ineffective
- A bond-financed increase in government spending shifts the πΌπ schedule to πΌπβ
- Little change in r, large change in Y
- Minimal crowding out of private spending
Describe Fiscal policy with a steep MP curve
Money demand is very responsive to changes in output
Fiscal policy is largely ineffective
- Increase in G shifts the IS schedule to IS1
- Large change in r, little change in Y
- Government spending has a large crowding out effect on private spending
What affects the slope of the IS curve
The slope of the IS curve is determined
by the responsiveness of aggregate
demand to change in interest rates
- The shift in AD when interest rates
change determines the corresponding
change in output
- This is determined by how sensitive
investment spending & consumption
are to r
* Larger shift in AD when π changes
results in larger changes to equilibrium
π β flat IS curve
Describe Monetary policy with a flat IS curve
πΌ and πΆ are very sensitive
to changes in the interest rate
Monetary policy is effective
Output is highly responsive to changes in the interest rate.
How will an increase in the Money Supply affect the IS-MP model (Monetary Policy)
Central bank increases the money supply, MP curve shifts to the right, IR decreases, stimulates I and C, right movement along IS curve = equilibrium output increases + real interest rate falls
How will an increase in Government Spending affect the IS-MP model (Fiscal Policy)
Increase in G, increases AD, IS curve shifts to the right, output increases, IR increases, decreases I + equilibrium output increases + real interest rate increases
What are the pros and cons of Monetary policy
Pros:
- Stimulates private investment and consumption
Cons:
- Zero (nominal) lower bound
- May be slow to work
- Cannot be targeted
What are the pros and cons of Fiscal policy
Pros:
- Can work fast
- Can be targeted
Cons:
- May lead to crowding out of private consumption
- Disagreement about the size of the multiplier
What does it mean for the IS-MP model if the MP curve is really steep
Households and firms are sensitive to interest rate changes, use monetary policy
The fiscal spending multiplier will be low, lots of crowding out
What does it mean for the IS-MP model if the MP curve is really flat
Households and firms are not sensitive to interest rate changes, use fiscal policy
The fiscal spending multiplier will be higher
