1. Explain and show graphically how monetary and fiscal policies can be used in the IS-LM framework. Within a closed economy IS-LM model, analyse the effects on income, the interest rate, consumption, and investment of the following: a) A fall in the government budget deficit. Explain how your answer is affected by whether the reduced deficit comes about through a fall in government purchases or a rise in tax revenue. b) A fall in the money supply. 2. Suppose the Government wishes to reduce the budget deficit by reducing public spending while holding taxes constant. Assuming that the monetary authorities hold the money supply constant, explain why the decrease in government spending affects output more in the IS model than in the IS-LM model.
1. Explain and show graphically how monetary and fiscal policies can be used in the IS-LM framework. Within a closed economy IS-LM model, analyse the effects on income, the interest rate, consumption, and investment of the following:
a) A fall in the government budget deficit. Explain how your answer is affected by whether the reduced deficit comes about through a fall in government purchases or a rise in tax revenue.
b) A fall in the money supply.
2. Suppose the Government wishes to reduce the budget deficit by reducing public spending while holding taxes constant. Assuming that the monetary authorities hold the money supply constant, explain why the decrease in government spending affects output more in the IS model than in the IS-LM model.
Please note: To help explain your answers and analysis, you should always attempt to use diagrams, mathematical demonstration where applicable and convey the economic intuitions behind the results. Do not forget to label your graphs.
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