15

2 The Global Macroeconomy (Subject) / IS-LM (Lesson)

This lesson was created by Janaw55.

Learn lesson

This lesson is not released for learning.

back  |  next 1 / 1

• i - Company Investment / Consumption & interest rate relationship if at optimal capital stock: increase in interest rates: new optimal capital below old  risk for investors (ROE higher) interest rate increase, bond prices fall Tax changes -> effect of expectation on inflation -> companies may not be able to reduce capital stock and decide to stop investing in future, du let capital depreciate Investment expenditure is likely to be much more volatile than consumption. The sensitivity of investment to the cost of borrowing is an important factor behind the shape of the IS curve. It would be unusual for an individual to decide to cut consumption to zero in response to news about interest rates or future incomes Technological progress: An increase in productivity raises the optimal stock of capital through productivity can simultaneously increase both gross investment and the scrapping of existing machines  Profound effect on productivity
• T - FDI & Tax Effect Flows of foreign direct investment (FDI) have increased greatly since the late 1980s. An increasing proportion of world investment is now undertaken by multinational companies. Why does marginal productivity of capital & cost of capital differ across countries? if technnology is common across countries, differences in capital-labor ratios and wages generate big differences in Marginal Return on Investment Differences in taxation tax wedge: difference between the required pretax return on relevant capital - interest rate required from a bank deposit, so as to generate the same after-tax return Tax systems differ greatly across countries, creating a wide range of incentive and disincentives to invest
• IS - Investment & Savings Equilibrium Equation Y = C (Y - T) + G + I(r) + (X-M(Y))
• IS - Right Shifters of IS Curve Y = C (Y - T - S) + G + I(r) + (X-M(Y)) (1) Fiscal Policy G Change in Fiscal Policy  - Increase in Government Spending (RIGHT SHIFT) T Change in Fiscal Policy  - Decrease Taxes increases C (RIGHT SHIFT) (2) Consumer Confidence About Future S Consumers Save Less (MPC increases) - Increase in Consumption (RIGHT SHIFT)  I  Consumer invest regardless of i - Increse in Private Investment (RIGHT SHIFT) (3) Net Exports RER Depreciation - Exports Increase (RIGHT SHIFT) M Decrease          - Imports Decreae (RIGHT SHIFT)
• LM - Liquidity * Money Supply Equilibrium Equation M / P = L (i,Y,V)
• LM - Right Shifters of LM CURVE M / P = L (i, Y, V) Real Money Supply = Real Demand for Money  (1)  Monetary Policy M - Quantitative Easing - Fed Buys Bonds  (RIGHT SHIFT = Increase in Money Supply = Increase in AG at CONSTANT INTEREST RATE) M - Fed decides to print money  M - Fed Lower's Reserve Requirements  M - Fed Lover's  Discount Rate (2) Transaction Technology Shock (Credit Cards) V - Consumers need less Cash in Pocket (Opportunity Cost increase) (RIGHT SHIFT)  (3) Deflation P - Price Decline (less money needed to pay lower prices BUT lower interest rates increase demand for holding money) (RIGHT SHIFT)
• i - Inflation & Interest rates Inverse correlation: i ↓ more people are able to borrow more money; consumers have more money to spend, causing the economy to grow and inflation to increase i ↑; consumers tend to save as returns from savings are higher; with less disposable income being spent as a result of the increase in the interest rate, the economy slows and inflation decreases. => This relationship forms one of the central tenets of contemporary monetary policy: central banks manipulate short-term interest rates to affect rate of inflation in the economy. Quantity Theory of Money: Supply and demand for money determines inflation If AG increases ↑ No Fed Response: No Increase in Interest Rate  M = Increase in inflation ↑ Fed Response: Increase Interest Rate ↑ = Decrease M & Decrease Inflation ↓
• M - Fed's 3 major methods by which to control the supply of money: 1) it can engage in open market operations2) change reserve requirements3) change its discount rate
• i - If FED wants to reduce M to slow inflation Increase Interbank Rate 
• i - Monetary Policy inflation effects if AG increases If AG increases ↑ No Fed Response: No Increase in Interest Rate  M = Increase in inflation ↑ Fed Response: Increase Interest Rate ↑ = Decrease M & Decrease Inflation ↓
• Advertisement
• DD - UP Shifters of DD DD = C (Y-T-S) + I (r) + G + X-M (Closed Economy, Sticky Prices, No Inflation, r=i) (1) Increase in Consumption (SHIFT UP) Y - Increase in Income T - Decrease in Taxes (sometimes pivot) S - Decrease in savings (2) Increase in Investment (SHIFT UP) r - Decrease in real interest rate  (3) Fiscal Policy: Increase in Government Spending (Exogenous UP) G - Budget lossened 
• i - Long Run Real interest Rate & Expected inflation I = f(r) -> the higher r the lower I   Long Run - r = i - 𝜋 (difference between the nominal interest rate and the expected inflation) Short Run - Assume Fixed Prices, Ignore Inflation expectations r = i
• i - Bond & interest rate relationship Y Increases, Income Increases Real Money Demand Increases - People want more Real Money (more $$ to consume) Real Money Supply is Fixed - Run on Banks Two Mechanisms: (1) Increase opportunity cost of Money -  Fed increases interest rate (2) Alternative Way to get Money - Sale of Bonds & Run on Banks (No $$) To get $$, People sell Bonds Price of Bonds drops & Interest Rate increases eventually
• p - Long Run Mechanism of Inflation Price Increase reduces Real Money Supply Scarcity of Real Money makes it more valuable People want to hold more $$ Interest Rate has to Increase - Higher interest rate reduces investment and consumption
• i - interest Rate at ZLB Makes Cash cheaper -> People will want to hold more $$ Reason why Peolpe are willing to pay minus 0.25 basis points -> Lack of Alternative Only Alternative: Buy Big safe, Security is Costly However, Test show that  -10%  would be too expensive 

back  |  next 1 / 1