IS/LM Model and New Classical Model Recent years have witnessed the development of a New IS-LM model that is increasingly being used to discuss the determination of macroeconomic activity and the design of monetary policy rules. It is sometimes called an optimizing IS-LM model because it can be built up from microfoundations. It is alternatively called an expectational IS-LM model because the traditional models behavioral equations are modified to include expectational terms suggested by these microfoundations and because the new framework is analyzed using rational expectations. The new model suggests that a monetary policy that targets inflation at a low level will keep economic activity near capacity. If there are no exogenous inflation shocks, then full stabilization of the price level will also maintain output at its capacity level. More generally, the new model indicates that time-varying inflation targets should not respond to many economic disturbances, including shocks to productivity, aggregate demand, and the demand for money. The new model incorporates the twin principles of interest rate determination, originally developed by Irving Fisher, which are an essential component of modern macroeconomics. The real interest rate is a key intertemporal relative price, which increases when there is greater expected growth in real activity and falls when the economy slows.
The Term Paper on Price Level Unemployment Inflation Demand
... - Unemployment: at lowest point, Price level (inflation): highest o Contraction - Unemployment: increasing, Price level (inflation): high o Recession - Unemployment: rapidly ... and incomes (e. g.policies to restrict the activities of trade unions), or by designing policies to ... to propagate itself throughout the economy.According to this model, rapid output growth stimulates investment. High investment ...
The nominal interest rate is the sum of the real interest rate and expected inflation. Accordingly, a central bank pursuing an inflation-targeting policy designed to keep output near capacity must raise the nominal rate when the economys expected growth rate of capacity output increases and lower it when the expected growth rate declines. There are two limits on monetary policy emphasized by this model. First, the monetary authority cannot engineer a permanent departure of output from its capacity level. Second, monetary policy rules must be restricted if there is to be a unique rational expectations equilibrium. In particular, as is apparently the case in many countries, suppose that the central bank uses an interest rate instrument and that it raises the rate when inflation rises relative to target. Then the New IS-LM model implies that it must do so aggressively (raising the rate by more than one-for-one) if there is to be a unique, stable equilibrium.
But if the central bank responds to both current and prospective inflation, then it is also important that it not respond too aggressively. Within the new model, monetary policy can induce temporary departures of output from its capacity level. However, in contrast to some earlier models, these departures generally will not be serially uncorrelated. If the central bank engineers a permanent increase in nominal income, for example, then there will be an increase in output that will persist for a number of periods before fully dissipating in price adjustment. Further, the model implies that the form of the monetary policy rule is important for how the economy responds to various real and monetary disturbances. Unlike IS/LM model, the Classical model of the economy says that all markets always clear.
The Essay on Interest Rate Increase Bank Rates
Objectives: Primary To successfully invest $200 m of funds into short term securities with the highest possible yield in order to maximise our return on profit. 10% of our funds are required to be invested in the overnight market and 50% should be available over the next 3 months. Secondary To speculate in the market according to interest rate movements over the next 6 months by buying and selling ...
The labor market failing to clear does not exist in the Classical model because of competitive exchange equilibrium in which prices and quantities always adjust perfectly. The Classical model is of a closed economy and the variables are real output, employment, real and nominal wages, the price level, and the rate of interest. One of the most serious criticisms levied at New Classical theory has centered on NCMs contention that business fluctuations would be eliminated if firms and individuals had accurate current information about the aggregate price level. Given that the Consumer Price Index is widely disseminated with a relatively short lag, this does not seem all that plausible. Further, other NCMs, such as Edward Prescott of the University of Minnesota, have argued that business fluctuations are predominately the result of real shocks as opposed to monetary shocks, and hence are caused by movements in aggregate supply instead of aggregate demand. He, and others, have branched out from the New Classical school of thought and developed the theory of real business cycles as an opposing view to the New Classical theory.
Money has different effects on the economy in these models. Because of the Classical dichotomy, only the nominal sector is effected by money in the classical model. But in the Keynes model, many things are effected by money. First, the interest rate decreases, which causes an increase in bond prices. The decrease in interest rate causes an increase in investment and then this causes an increase in aggregate demand, which then causes income and employment to increase. This can be seen in diagram four, and then because of the increase in income, going back to graph three, we can see that this would cause an increase in consumption.
From diagram five, we can see because of the increase in employment that this would cause a decrease in real wages. The decrease in real wages would then cause involuntary unemployment to decrease. Because of the different effects that money has on the economy in these models, they arrive at different conclusions. The Classical economy seems to be in favor of no policy since everything works itself out and ends up in equilibrium since all the markets clear. The opposite is true for the Keynes model, where they are in favor of government intervention since it is not inherently self-regulating and the markets do not clear. The Keynes model needs a little help from the government, or the central bank, to achieve equilibrium, where as the Classical model, assuming all assumptions were realistic, is self-regulating and all markets clear.
The Essay on The increase or decrease in CO2 emission
Purpose The purpose of this report is to determine the increase or decrease in CO2 emission over the past 40 years. Showing that human activity is the reason for the altering of the CO2 emissions to the earth. Resulting in the unbalancing of ecosystems across the globe. (M.U.S.E., 2010) Introduction Carbon dioxide is naturally present in the atmosphere as part of the Earth’s carbon cycle. ...
Bibliography:
Laurence Ball, N.
Gregory Mankiw, & David Romer. The New Keynesian Economics and the Output-Inflation Trade-off, Brookings Papers on Economic Activity (1998:1), 1-65. Robert Gordon. What is New Keynesian Economics?, Journal of Economic Literature (September 1999), 1115-1171..
