INTRODUCTION: Keynesian framework IS-LM Model According to Dornbusch (2011), the IS-LM model was

1100 WordsApr 23, 20195 Pages
INTRODUCTION: Keynesian framework IS-LM Model According to Dornbusch (2011), the IS-LM model was invented by Hicks in 1937. IS stands for investments and savings in the goods market while LM stands for liquidity preference and money supply in the money market. The model emphasizes the interaction between the goods and assets markets. Spending, interest rates and income are determined jointly by equilibrium in the goods and assets markets. The IS curve shows various combinations of interest rates and levels of income at which the goods markets clear while the LM curve shows that the demand for money depends on the interest rate and income and there are various combination of interest rates and income levels, at which the money market…show more content…
It was reduced to 0.3 percent and was further reduced to 0.1 percent in 2008. The Monetary Policy Meeting increased the amount of outright purchases of Japan Government Bonds from 14.4 trillion yen to 16.8 trillion yen. The Keynesian framework is not a good instrument to study this event because its assumptions are based on sticky prices, closed economy in the short run and flexible interest rate while the event shows an open economy, flexible prices and the type of interest rate is stated. ANALYSIS USING THE KEYNESIAN FRAMEWORK An Increase in Government Spending An increase in government spending by $156 billion shifts the IS curve to the right from IS1 to IS2 which raises income from Y1 to Y2 and increases consumption in the goods market. This causes an excess demand for money (Md) which leads to an increase in the interest rate from r1 to r2 in the money market. As a result, investments will fall in the goods market. The shift in the IS curve from IS1 to IS2 is by 1/1-MPC ∆ G. The marginal propensity to consume for japan is 0.36 (OECD, 2011). The multiplier effect will be 1/1-0.36= 1.5625 Therefore: 1.5625 × $156 billion = $243.73 billion A Tax Cut A tax rebate per person of $120 and $80 for under eighteen and over sixty-five shifts the IS curve to the right from IS1 to IS2 which increases income from Y1 to Y2 and raises consumption in the goods market. This causes a rise in demand for money (Md)

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