TAILIEUCHUNG - The economics of Money, Banking and Financial Markets Part 11

Ch a p ter 24 Monetary and Fiscal Policy in the ISLM Model. Since World War II, government policymakers have tried to promote high employment without causing inflation. If the economy experiences a recession such as the one that began in March 2001 | Chapter 24 Monetary and Fiscal Policy in the ISLM Model PREVIEW Since World War II government policymakers have tried to promote high employment without causing inflation. If the economy experiences a recession such as the one that began in March 2001 policymakers have two principal sets of tools that they can use to affect aggregate economic activity monetary policy the control of interest rates or the money supply and fiscal policy the control of government spending and taxes. The ISLM model can help policymakers predict what will happen to aggregate output and interest rates if they decide to increase the money supply or increase government spending. In this way ISLM analysis enables us to answer some important questions about the usefulness and effectiveness of monetary and fiscal policy in influencing economic activity. But which is better When is monetary policy more effective than fiscal policy at controlling the level of aggregate output and when is it less effective Will fiscal policy be more effective if it is conducted by changing government spending rather than changing taxes Should the monetary authorities conduct monetary policy by manipulating the money supply or interest rates In this chapter we use the ISLM model to help answer these questions and to learn how the model generates the aggregate demand curve featured prominently in the aggregate demand and supply framework examined in Chapter 25 which is used to understand changes not only in aggregate output but in the price level as well. Our analysis will show why economists focus so much attention on topics such as the stability of the demand for money function and whether the demand for money is strongly influenced by interest rates. First however let s examine the ISLM model in more detail to see how the IS and LM curves developed in Chapter 23 shift and the implications of these shifts. We continue to assume that the price level is fixed so that real and nominal quantities are the same. .

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