Transcript ISLM: Part III: The Monetary Sector (with MV=PQ in play)

ISLM Analysis
Part III: The Monetary Sector
(with MV=PQ in play)
The Keynesian Framework
According to John Hicks and Alvin Hansen
Roger W. Garrison
2010
S
S
Seq
i
ieq
i
MS
MS
MSPEC
ieq
Y
I
i
IS
Yeq Y
Ieq
I
Keynes’s
But Keynes
hard-drawn
did recognize
version
another
of thecomponent
monetary sector
of the gives
demand
no play
for money.
to the The
equation
transactions
of exchange.
demand for
Themoney
whole(M
story
is—or
about
simply
the supply
MT) depends
of money
primarily
TRANS
and
on income
the speculative
and not so
demand
much for
on money.
the interest
The rate.
interest
It israte,
this which
component (MT)
balances
supply
against
demand
is aequation
purely monetary
phenomenon.
that can be
analyzed
in terms
of the
of exchange.
Y/P = Q
(MV)0
P
MT
So, how is MT graphed as
a function of Y?
Y = PQ
The classical economists wrote:
Keynes recognized that the
transactions velocity of money, like
the velocity of money in the
classical formulation, is fairly
stable. VT is more or less constant.
MV = PQ, where Q also represents
real income—i.e., Q = Y/P.
Since Q = Y/P, then PQ = Y.
So, we can write MV = Y, which
applies, Keynes insisted, only to the
transactions demand for money.
This means that MT is linearly
related to Y. MT = Y/ VT graphs as
a straight line that emanates from
the origin and has a slope of 1/VT.
And so, MTVT = Y or MT = Y/VT
MT
1
VT
Y
Y/P = Q
(MV)0
P
MT
So, how is MT1 graphed as
V
a function
of Y?
T
Y = PQ
MT is one component of the demand for money.
The other component is MSPEC.
The monetary sector is in
equilibrium when money
Keynes took the two components to be additive. supply equals money
That is, the total demand for money (MD) is equal demand.
to MSPEC plus MT. [Or simply: MD = MSPEC + MT]
Simply written: MS = MD.
i
So, MS = MSPEC + MT,
where MS is controlled by
the central bank.
MSPEC
MT
This equilibrium condition
graphs as a straight line
with a vertical intercept of
MS, a horizontal intercept
of MS and a slope of
negative one.
MT
1
MS
VT
1
1
S
MSPEC
Y
The
supply is managed
by thefor
central
MT ismoney
one component
of the demand
money.
bank,
i.e, the
Federal Reserve.
The other
component
is MSPEC. So, the Fed can
increase or decrease MS, as deemed necessary.
Keynes took the two components to be additive.
As
thethe
case
the hard-drawn
version
D) of
Thatin is,
totalofdemand
for money
(M
is equal
S
Keynes’s
model,
in M
to MSPEC plus
MT.changes
[Or simply:
MD can
= Minfluence
SPEC + MT]
both income and the interest rate.
i
MT
MSPEC
Simply written: MS = MD.
So, MS = MSPEC + MT,
where MS is controlled by
the central bank.
This equilibrium condition
graphs as a straight line
with a vertical intercept of
MS, a horizontal intercept
of MS and a slope of
negative one.
MT
1
VT
MSPEC
The monetary sector is in
equilibrium when money
supply equals money
demand.
Y
The two (additive) demands for money
together with the equilibrium condition imply
possible combinations of income and the
interest rate that are consistent with
equilibrium in the monetary sector.
i
MT
i
MSPEC
MSPEC
MT
LM
Y
Y
The line connecting the
possible equilibrium points
is called the LM curve—with
L (liquidity) representing the
demand for money and M
representing money supply.
The two (additive) demands for money
together with the equilibrium condition imply
possible combinations of income and the
interest rate that are consistent with
equilibrium in the monetary sector.
i
MT
i
MSPEC
MSPEC
MT
LM
Y
Y
The line connecting the
possible equilibrium points
is called the LM curve—with
L (liquidity) representing the
demand for money and M
representing money supply.
S
The Keynesian Framework
According to John Hicks
and Alvin Hansen
S
Seq
W
S
i
i
ieq
ieq
MT
MSPEC
MT
Y
LM
i
LABOR
INCOME
D
I
N
IS
Yeq Y
Ieq
I
This is the Hicks-Hansen, fixed-price,
eight-quadrant diagrammatical
exposition of Keynesian
Macroeconomics.
MSPEC
Y
S
The Keynesian Framework
According to John Hicks
and Alvin Hansen
Seq
i
i
ieq
ieq
MT
MSPEC
S
MT
Y
LM
i
IS
Yeq Y
Ieq
I
The “animal
speculative
spirits”
demand
that govern
for money,
investment
which
reflects the
demand
can“fetish
wax and
of liquidity”
wane, causing
is similarly
unstable. movements
amplified
A strengthening
in theorISweakening
curve. of
the fetishspirits
Waxing
generates
can result
a mirror-image
in inflation; waning
spirits
can result
movement
of the inLMunemployment.
curve.
Watch.
MSPEC
I
Y
S
The Keynesian Framework
According to John Hicks
and Alvin Hansen
Seq
i
i
ieq
ieq
MT
MSPEC
S
MT
Y
LM
i
IS
Yeq Y
Ieq
I
“Animal spirits” and the “fetish of liquidity”
can interact, setting both the IS curve and
the LM curve in motion. Fine tuning such a
macroeconomy with fiscal and monetary
policy is the ultimate “mission incredible.”
Watch.
MSPEC
I
Y
S
The Keynesian Framework
According to John Hicks
and Alvin Hansen
S
Seq
i
i
ieq
ieq
Y
LM
I
i
IS
MT
MSPEC
MSPEC
MT
Yfe Y
Ieq
I
Even without “animal spirits” and the
“fetish of liquidity,” monetary policy
may not be able to lift the economy
out of recession. The obstacles come
in the form of the “Liquidity Trap” and
the “Stagnation Thesis.”
Y
ISLM Analysis
Part III: The Monetary Sector
(with MV=PQ in play)
The Keynesian Framework
According to John Hicks and Alvin Hansen
Roger W. Garrison
2010