IS-LM Model Short-Run Analysis

Short-run macroeconomic analysis focusing on the derivation, shifts, and empirical evidence of the IS-LM model.

What were the unemployment and real GDP statistics for the United States in the worst year of the Great Depression ($1933$)?

The US labour force was $25\%$ unemployed and real GDP was $30\%$ below its $1929$ level.

According to classical economic theory, what two factors determine national income?

Factor supplies (such as labour and capital) and available technology.

In his $1936$ book, 'The General Theory of Employment, Interest and Money', what did Maynard Keynes argue was responsible for low income and high unemployment?

Low aggregate demand.

How does the model of aggregate demand and aggregate supply distinguish between price behavior in the long-run and the short-run?

In the long-run prices are flexible and aggregate supply determines income, but in the short-run prices are sticky, so changes in aggregate demand influence income.

Who introduced the IS-LM model in the article 'Mr Keynes and the Classics: A Suggested Interpretation' ($1937$)?

John R. Hicks.

What do the components 'IS' and 'LM' stand for in the IS-LM model?

IS stands for investment and saving, and LM stands for liquidity and money.

What is the equilibrium condition for the goods market, and what is this relation now called?

The condition is that output $Y$ must be equal to the demand for goods $Z$ ($Y = Z$), which is called the IS relation.

According to the expanded IS-LM model, what are the two primary factors that investment ($I$) depends on?

The level of sales ($Y$) and the interest rate ($i$).

What is the expanded IS equation representing equilibrium in the goods market?

$$Y = C(Y - T) + I(Y, i) + G$$

Why is the IS curve downward sloping?

Because an increase in the interest rate leads to a decrease in investment, which leads to a decrease in output through the multiplier effect.

For a given interest rate, what effect does an increase in taxes ($T$) have on the IS curve?

It decreases disposable income and consumption, shifting the IS curve to the left.

What is the LM equation relating real money, real income, and the interest rate?

$$\frac{M}{P} = L(Y, i)$$

In the short-run IS-LM model, why is the LM curve represented as a horizontal line?

It is assumed that the central bank chooses a specific interest rate and adjusts the money supply to maintain that level.

What does a 'fiscal expansion' entail within the IS-LM framework?

An increase in the budget deficit, either through an increase in government spending ($G$) or a decrease in taxes ($T$).

How does a decrease in the interest rate (expansionary monetary policy) affect investment and output?

The lower interest rate leads to an increase in investment, which increases demand and output ($Y$).

What is meant by the 'monetary-fiscal policy mix'?

The simultaneous application of both fiscal and monetary policy to influence economic outcomes.

What is 'dynamics' in the context of economic policy analysis?

How the economy adjusts over time after a shock or policy change, including the path and speed at which it reaches a new equilibrium.

Based on the empirical study of US data from $1960$ to $1990$, how long does it take for monetary policy to have its full effect on production?

Eight quarters (or $2$ years), with a maximum decrease in output of $-0.7\%$ following a $1\%$ increase in the federal funds rate.

According to the research by Christiano, Eichenbaum, and Evans ($1996$), which variable reacts to monetary policy with a shorter lag than output and employment?

Unemployment, which takes approximately $4$ quarters ($1$ year) to reach its peak effect.

How does a $1\%$ increase in the federal funds rate affect commodity prices according to the provided empirical evidence?

It leads to a decline in commodity prices, with the largest decrease of $-0.2\%$ observed after three quarters.