What is the purpose of the IS-LM model?

The IS-LM model attempts to explain a way to keep the economy in balance through an equilibrium of money supply versus interest rates. The IS-LM is also sometimes called the Hicks-Hansen model.

IS-LM model formula?

The basis of the IS-LM model is an analysis of the money market and an analysis of the goods market, which together determine the equilibrium levels of interest rates and output in the economy, given prices. The model finds combinations of interest rates and output (GDP) such that the money market is in equilibrium.

What causes liquidity trap?

A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Among the characteristics of a liquidity trap are interest rates that are close to zero and changes in the money supply that fail to translate into changes in the price level.

What are the implications of IS and LM curves?

The IS-LM model has a major implication for monetary policy: when the IS curve is unstable, a money supply target will lead to greater output stability, and when the LM curve is unstable, an interest rate target will produce greater macro stability.

What are some problems with IS-LM analysis?

The IS-LM model, however, suffers from two serious limitations: (a) It is a comparative-static equilibrium model. It ignores the time-lags which are important in examining the effects of economic policy changes. (b) If has been called the fix-price model.

What shifts the IS curve?

Movements along the IS curve: As interest rates rise, output falls. Shifts in the IS curve: As government spending increases, output increases for any given interest rate. IS Curve: At lower interest rates, equilibrium output in the goods market is higher. An increase in government spending shifts out the IS curve.

What does the IS curve represent?

The IS curve shows combinations of interest rates and levels of output such that planned spending equals income. ‘OR’ The IS Curve represents various combinations of interest and income along which the goods market is in equilibrium.

What is liquidity trap in simple words?

Definition: Liquidity trap is a situation when expansionary monetary policy (increase in money supply) does not increase the interest rate, income and hence does not stimulate economic growth. Description: Liquidity trap is the extreme effect of monetary policy.

How do you escape liquidity trap?

Once in a liquidity trap, there are two means of escape. The first is to use expansionary fiscal policy. The second is, again, to lower the zero nominal interest rate floor. There are likely to be significant shoe leather costs associated with any scheme to tax currency.

What is the difference between IS-LM and LM model?

The LM stands for Liquidity and Money. On the vertical axis of the graph, ‘r’ represents the interest rate on government bonds. The IS-LM model attempts to explain a way to keep the economy in balance through an equilibrium of money supply versus interest rates. The IS-LM is also sometimes called the Hicks-Hansen model.

What is the is and LM model in economics?

The IS stands for Investment and Savings. The LM stands for Liquidity and Money. On the vertical axis of the graph, ‘r’ represents the interest rate on government bonds. The IS-LM model attempts to explain a way to keep the economy in balance through an equilibrium of money supply versus interest rates.

How do you break down the IS LM model?

BREAKING DOWN ‘IS-LM Model’. According to the theory, liquidity is determined by the size and velocity of the money supply. The levels of investing and consumption are determined by the marginal decisions of individual actors. The IS-LM graph examines the relationship between real output, or GDP, and nominal interest rates.

How is the IS-LM model related to the Keynesian short run model?

Putting the two component curves of the IS-LM model together gives us the Keynesian short-run model of economic management. The intersection of the two curves gives us the equilibrium level interest rate and output rate in the economy i.e. stability in both the goods/services market and the money market.