Title Keynesian system with money interest and income.pdf ✅

Unit V: Keynesian System with Money, Income and Interest Monetary and Fiscal Policy Mix in ISLM Framework Online Class via ZOOM 2020/7/19 Monday (Shrawan 5, 2077 BS) -Madhav Prasad Dahal, PhD 1
Relative Effectiveness of Fiscal Policy in the IS-LM Model Expansionary/Easy Fiscal Policy: 2 ❑ Fiscal policy is effective in the horizontal segment (Keynesian range) of the LM curve; With the increase in G or cut in T or a combination of both shifts IS curve from IS1 to IS2 and increases Y from Y1 to Y2 without rise in the interest rate. ❑ Fiscal policy is ineffective in the vertical segment (Classical range) of the LM curve; the rightward shift of the IS curve from IS1 to IS2 causes increase in r from r5 to r6 with no increase in Y that remains at Y5 . ❑ In the intermediate range (positively sloped part ) of the LM curve, fiscal policy is effective. As IS curve shifts from IS3 to IS4 , Y rises from Y3 to Y4 , but there is increase in r from r2 to r3 . Interest rate (r) LM Y1 A r1 0 B Y2 Real GDP/Income IS1 IS2 IS3 IS4 IS5 IS6 Y3 Y4 Y5 r2 r3 r4 r5 r6 E1 E2 E3 E4 E5 E6
The Classical or Monetarist Range of the LM Curve ❑ In the classical range, the LM curve is perfectly inelastic and the IS5 curve intersects it at E5 so that the interest rate is 0r5 and the income level is OY5 . When the government expenditure increases for an expansionary fiscal policy, the IS5 curve shifts upward to IS6 . As a result, the IS6 curve crosses the LM curve at E6 and the interest rate rises to Or6 with income remaining unchanged at OY5 . ❑ This is because the classical case relates to a fully employed economy where the increase in government expenditure has the effect of raising the interest rate which reduces private investment. Since the increase in government expenditure exactly equals the reduction in the private investment, there is no effect on the level of income which remains constant at OY5 . Thus fiscal policy is not at all effective in the classical range. 3
Fiscal Policy when the LM Curve is Positively Sloped ❑ The increase in both the income level and the interest rate in the intermediate range is due to two reasons. ❑ First, the increase in income resulting from a rise in government expenditure occurs because additional money balances are available for transactions purposes; Y increases due to increased government expenditure multiplier effect. Second, given a fixed money supply, a part of available transactions are held as idle balances by wealth holders which raise the interest rate. As a result of the rise in the interest rate, investment falls and the fiscal policy is not so effective as in the Keynesian range. In general, fiscal policy will be more effective the closer equilibrium is to the Keynesian range and less effective the closer equilibrium is to the classical range. 4