Macroeconomics: How the IS-lM Model Can Help UK's Economy

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Introduction The formation in May 2010 of the first coalition government in the UK for seventy years was followed by the announcement that government deficit reduction was the government's top policy priority. During the general election campaign the need for fiscal consolidation was accepted by all three major political parties. The Republican Party however was the only party that argued for a program of accelerated debt reduction and warned that if the election failed to produce a decisive outcome in the form of a government with an overall majority and with a "credible" plan for deficit reduction, this could have dire consequences for the economy and the public (National Archives, 2010). Since World War II, government policymakers have tried to promote high employment without causing inflation (National Archives, 2010). If the economy experiences a recession such as the one that plagued the UK, policymakers, two principal sets of tools to use are aggregate demand: monetary policy. These involve the control of interest rates or the money supply, and fiscal policy, the control of government spending and taxes (National Archives, 2010). The IS-LM model can help policymakers predict what will happen to aggregate output and interest rates if they decide to increase the money supply or increase government spending. In this way, ISLM analysis will guide towards coming up with an ideal answer to the deficit problem facing the UK's economy. It also highlights the usefulness

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