tailieunhanh - Lecture Principles of money, banking, and financial markets (12th edition): Chapter 25 - Ritter, Silber, Udell

Chapter 25 - Money and economic stability in the ISLM world. In this chapter you will learn to explain the circumstances under which fiscal or monetary policy is a more effective method of stabilizing GDP, understand the importance of crowding out and possible liquidity traps, define the role of prices and their impact on economic stability. | Chapter 25 Money and Economic Stability in the ISLM World Copyright © 2009 Pearson Addison-Wesley. All rights reserved. Learning Objectives • Explain the circumstances under which fiscal or monetary policy is a more effective method of stabilizing GDP • Understand the importance of crowding out and possible liquidity traps • Define the role of prices and their impact on economic stability Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 25-2 Monetary Policy, Fiscal Policy, and Crowding Out • Controversy within the ISLM framework relates to the relative effectiveness of monetary and fiscal policy • Monetarists “special case” (Figure ) – Demand for money is unresponsive to interest rates, depends on income only – Produces a vertical LM function – Since velocity is constant and a fixed money supply, GDP cannot change Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 25-3 1 FIGURE When the LM curve is vertical, an increase in the money supply increases income by ∆M times velocity. Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 25-4 Monetary Policy, Fiscal Policy, and Crowding Out (Cont.) • Monetarists “special case” (Figure ) (Cont.) – Increase in the money supply shifts the LM curve to the right along a fixed IS curve – Income increases until all the increased money supply is absorbed into increased transactions demand Copyright © 2009 Pearson Addison-Wesley. All rights reserved. 25-5 Monetary Policy, Fiscal Policy, and Crowding Out (Cont.) • Figure – LM curve is not vertical, but is positively sloped – Demand for money is somewhat responsive to rate of interest – Increase in money supply will result in an increase in income, but less than in the monetarist’s case – Smaller increase in income is due to lowering of interest rates inducing holding of money in “idle” balances rather than for transactions purposes – Therefore velocity of the total money supply falls Copyright © 2009 Pearson .