Monetary Theory II: The IS-MP Model

IS curve

Curve showing equilibrium in the market for goods and services

MP curve

Curve representing the real interest rate resulting from monetary policy

IS curve

Curve showing equilibrium in the market for goods and services

MP curve

Curve representing the real interest rate resulting from monetary policy

Phillips curve

Curve showing the short-term relationship between inflation and the output gap

IS-MP model

Model explaining interest rate, inflation rate, and changes in real GDP

Real interest rate

Interest rate adjusted for inflation

Monetary Policy Curve (MP)

Curve showing the real interest rate resulting from monetary policy by the Fed

Investment Savings Curve (IS)

Curve showing equilibrium in the market for goods and services

Phillips Curve (PC)

Curve showing the short-term relationship between inflation and the output gap

Aggregate expenditure (AE)

Total spending represented by consumption, investment, government purchases, and net exports

Consumption function

Equation representing the relationship between consumption and income

Marginal propensity to consume (MPC)

Proportion by which consumption changes when income changes

Planned investment

Planned investment equals actual investment minus unplanned changes in inventories

Equilibrium

Occurs when total spending equals total production

Multiplier effect

When autonomous expenditures increase, there is an even larger increase in real GDP

Multiplier

The change in real GDP resulting from a change in autonomous expenditures

Negative output gap

Occurs when the economy is producing below equilibrium

Positive output gap

Occurs when the economy is producing above equilibrium

Multiplier equation

Equation to calculate the change in real GDP based on the multiplier and change in autonomous expenditures

Okun's Law

Statistical relationship that says a 2% drop in the output gap is associated with about a 1 percentage point increase in the unemployment rate

IS curve shift

Occurs when aggregate expenditures increase, causing the IS curve to shift rightward

MP curve shift

Occurs when the Fed undertakes expansionary policy, causing the MP curve to shift upward

Phillips curve shift

Occurs when inflation expectations increase or a negative supply shock occurs, causing the Phillips curve to shift upward

Negative demand shock

Occurs when there is a decrease in aggregate expenditures, causing the IS curve to shift inward

Negative supply shock

Occurs when there is a negative shock to the supply side of the economy, causing the Phillips curve to shift upward

Interest rate channel

The effect of changes in interest rates on borrowing, spending, and output

Bank lending channel

The effect of changes in commercial bank lending on borrowing, spending, and output

Shadow bank lending

The effect of changes in shadow bank lending on borrowing, spending, and output

Balance sheet channel

The effect of changes in borrowers' net worth on borrowing, spending, and output

Arthur Okun

Economist known for Okun's Law

A. W. Phillips

Economist known for the Phillips curve

Paul Volcker

Former chairman of the Federal Reserve known for his efforts to reduce inflation