Monetary and fiscal policy

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Monetary and fiscal policy
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Preview

• Fiscal policy
• Monetary policy
• Taylor rule
• The IS schedule
• The LM schedule
• Fiscal policy shifting the IS schedule
• Monetary policy shifting the LM schedule
• The policy mix

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Fiscal policy

• A given fiscal policy means a given path of
  government spending, and a given path of tax
  rates that eventually raise enought tax revenue
  to pay for this spending.

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Monetary policy

• A given monetary policy must specify the
  implicit decision rule by which interes rate are
  set. This could be to achieve a monetary target,
  an inflation target, or follow a Taylor rule.

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Monetary targeting

• A monetary targeting implies that
• income is high -gt real money demand is high -gt
  interest rates are high to reduce the money
  demand
• income is low -gt real money demand is low -gt
  interest rates are low
• Monetary targeting helps stabilize
• aggregate demand for output.

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Inflation target

• An inflation target implies interest rates are
  adjusted to keep inflation within a narrow range.

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Taylor rule

• A Taylor rule means that interest rates deviate
  from their target rate only because output or
  inflation are expected to deviate from their
  target rates.
• According to this rule, central banks
• raise interest rates if inflation and output are
  epected to be above their target levels
• lower interest rates if inflation and output are
  expected to be below their target levels

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Interest rates in a Taylor rule
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The IS schedule

• The IS schedule (Investment/Saving equilibrium)
  shows combinations of interest rates and output
  compatible with short-run equilibrium output in
  the goods market.

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The IS schedule
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The LM schedule

• The LM schedule (Liquidity preference/Money
  supply equilibrium) shows combinations of
  interest rates and output compatible with money
  market equilibrium.

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The LM schedule
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Equilibrium in goods and money markets

• The intersection of IS and LM schedules shows
  simultaneous equilibrium in both goods and money
  market, jointly determining output and interest
  rate.

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Equilibrium in goods and money markets

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Shifting the IS and LM schedule
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Shifting the IS and LM schedule
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Shifting the IS and LM schedule
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The policy mix
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THE END

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