MacroEcon 10

MacroEcon 10

1. ·

   • Suppose Parliament increases G.  Possible Bank of England responses: 1. Hold M constant 2. Hold r constant 3. Hold Y constant  In each case, the effects of the G are different:

2. Shocks in IS LM

   • IS shocks: Exogenous changes in the demand for goods and services. These include what Keynes called “animal spirits.” They can also be self-fulfilling waves of optimism and pessimism.
     • Stock market boom or crash ↑⇒ change in households’ wealth ↑ ⇒C
   • LM shocks: Exogenous changes in the demand for money.

3. ·

   • • • THE SPENDING HYPOTHESIS: Shocks to the IS curve  The spending hypothesis asserts that the Great Depression was largely due to an exogenous fall in the demand for goods and services – this is a leftward shift of the IS curve.  Evidence supporting this hypothesis: Output and interest rates both fell, which is what a leftward IS shift would cause
         • A shock to the LM curve  The money hypothesis asserts that the Great Depression was largely due to a huge fall in the money supply
           • The destabilising effects of expected deflation: Firms delay investment because the real interest rate gets pushed up by deflation. The destabilising effects of unexpected deflation is called the debt-deflation theory.

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