What determines the relative effectiveness of fiscal and monetary policy in the IS-LM model of a close economy?

calendar November 20, 2008
fiscal
James B asked:


I have lost all my notes for an exam I have on monday and my lecturer does not put any notes on the internet so all I am able to go on is a few scraps of notes and the learning objectives of the course (which this and my previous question is one of). Also If anyone knows of a good online free (poor student :( ) notes resource for degree level macroeconomics that would be great!

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4 Responses to “What determines the relative effectiveness of fiscal and monetary policy in the IS-LM model of a close economy?”

  1. crimsonedge Says:
    November 21st, 2008 at 6:36 pm

    The effectiveness depends on the slope of each curve i.e. if one is steeper or flatter than one another. It’s important to remember what policies affect what curve; (LM is affected by monetary policy while IS is affected by fiscal policy)

    If you draw out the IS/LM curve with a flat LM curve you’ll see how monetary policy will have no/little affect and with a vertical LM curve monetary policy has a huge affect.

    Now if you used fiscal policy with a flat LM curve you will have a huge affect while a vertical one will be ineffective.

    You can do the same with a steep and flat IS curve and figure out which policy will work in each case.

    I’m sure if you used your favorite search engine that you can find many marco notes online since many universities post notes and it’s all the same.

  2. Jane Says:
    November 22nd, 2008 at 7:23 am

    Effectiveness is measured as the impact to Y (GDP or output or x-axis of this model). I believe the effectiveness of either policy depends on the elasticities of the IS and LM curves.

    Fiscal policy is most effective when LM (M/P) is flat or elastic and IS (C+I+G) is steep or inelastic. When government spending increases or decreases (shifts in IS), there is significant change in Y and minimal impact to r. IMPORTANT: changes in G will correspond to a shift in the Aggregate Supply & Demand model as well and results in a change in P. Both the IS and LM curves shift when there is a change in G.

    Monetary policy is the most effective when IS is horizontal and LM is vertical (the vice versa case of optimal conditions for fiscal policy). Changes in the money market model (shift in LM) result in a significant change in Y and minimal impact to r. Only the LM curve shifts in this case.

    I recommend studying with people in your class.

  3. dilberts03 Says:
    November 22nd, 2008 at 8:09 pm

    1. Wages and Prices flexible
    2. Private investement spending responds to interest rate changes. (IS curve is not vertical)
    3. The economy is not on a liquidity Trap (i.e., LM curve is not flat)

  4. Joseph H Says:
    November 25th, 2008 at 4:52 am

    the government