ECOS2002 - Tutorial 4
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ECOS2002 - Tutorial 4
1. Consider the following IS–LM model:
Y = C + I
C = c0 + c1 (Y − 
) I = I0 − I1i
MD = L0Y − L1i
(a) Derive the IS relation. (Hint: You want an equation with Y on the left side,
all else on the right.)
(b) Derive the LM relation.
(c) Solve for equilibrium real output. (Hint: Substitute the value for the interest rate into the IS equation and solve for output.)
2. Policy in the IS-LM model. For each of the scenarios below, what is the effect on the equilibrium interest rate and equilibrium output. Use a graph in your answer. Assume an upward sloping LM curve.
(a) The central bank is conducting contractionary monetary policy, that is de- creasing money supply.
(b) The government decides to increase spending.
(c) The government decides to increase taxes to close its budget deficit but the central bank is committed to keep the interest rate constant.
3. The zero lower bound and the effectiveness of monetary policy:
(a) Draw the money market graph we learned in class with a dotted line equal to the nominal interest rate at the zero lower bound. Place money demand and money supply in the graph. (Hint: think carefully about how money demand at the zero lower bound should be drawn)
(b) Using the money market graph you created in a), derive the LM curve.
(c) Is fiscal policy more powerful or less powerful at the zero lower bound accord- ing to the IS/LM model?
4. Discussion
Why does a zero lower bound for nominal interest rates exist? And even though the zero lower bound exists, some central banks have recently managed to actually push nominal interests rates to negative values . Can you come up with a reason why deposits are not converted into cash for small, in absolute value terms, negative interest rates?
2022-11-25