MACROECONOMICS
cover art ROW 1 (90)
C H A P T E R
© 2008 Worth Publishers, all rights reserved
SIXTH EDITION
PowerPoint® Slides by Ron Cronovich
N. GREGORY MANKIW
Aggregate Demand II:
Applying the IS -LM Model
11

This is a very substantial chapter, and among the most challenging in the text.  I encourage you to
go over this chapter a little more slowly than average, or at least recommend to your students that
they study it extra carefully.
I have included a number of in-class exercises to give students immediate reinforcement of concepts
as they are covered, and also to break up the lecture.  If you need to get through the material
more quickly, you can omit some or all of these exercises (perhaps assigning them as homeworks,
instead).
A graph unfolds on slides 29-33.  If you create handouts of this file for your students (or create
a PDF version for them to download from the web), you might consider omitting slides 30 and 32 to
save paper, as they contain intermediate animations.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Context
§Chapter 9 introduced the model of aggregate demand and supply.
§Chapter 10 developed the IS-LM model,
the basis of the aggregate demand curve.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
In this chapter, you will learn…
§how to use the IS-LM model to analyze the effects of shocks, fiscal policy, and monetary policy
§how to derive the aggregate demand curve from the IS-LM model
§several theories about what caused the
Great Depression

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
The intersection determines
the unique combination of Y and r
that satisfies equilibrium in both markets.
The LM curve represents money market equilibrium.
Equilibrium in the IS -LM model
§The IS curve represents equilibrium in the goods market.
IS
Y
r
LM
r1
Y1

Review/recap of the very end of Chapter 10.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Policy analysis with the IS -LM model
§We can use the IS-LM model to analyze the effects of
•fiscal policy: G  and/or T
•monetary policy:  M
IS
Y
r
LM
r1
Y1

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
causing output & income to rise.
IS1
An increase in government purchases
§1.  IS  curve shifts right
Y
r
LM
r1
Y1
IS2
Y2
r2
1.
2.  This raises money demand, causing the interest rate to rise…
2.
3.  …which reduces investment, so the final increase in Y
3.

Chapter 10 showed that an increase in G causes the IS curve to shift to the right by (G)/(1-MPC).

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
IS1
1.
A tax cut
Y
r
LM
r1
Y1
IS2
Y2
r2
Consumers save (1-MPC) of the tax cut, so the initial boost in spending is smaller for DT  than for
an equal DG…
and the IS curve shifts by
1.
2.
2.
…so the effects on r
and Y are smaller for DT  than for an equal  DG.
2.

Chapter 10 used the Keynesian Cross to show that a decrease in T causes the IS curve to shift to
the right by (-MPCT)/(1-MPC).
If your students ask why the IS curve shifts to the right when there’s a negative sign in the
expression for the shift, remind them that T < 0 for a tax cut, so the expression actually is
positive.
The term showing the distance of the shift in the IS curve is almost the same as in the case of a
government spending increase, where the numerator of the fraction equals (1) for government
spending rather than (-MPC) for the tax cut.  Here’s the intuition:  Every dollar of a government
spending increase adds to aggregate spending.  However, for tax cuts, the fraction (1-MPC) of the
tax cut leaks into saving, so aggregate spending only rises by MPC times the tax cut.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
2. …causing the interest rate to fall
IS
Monetary policy:  An increase in M
§1.  DM > 0 shifts
the LM curve down
(or to the right)
Y
r
LM1
r1
Y1
Y2
r2
LM2
3. …which increases investment, causing output & income to rise.

Chapter 10 showed that an increase in M shifts the LM curve to the right.
Here is a richer explanation for the LM shift:
   The increase in M causes the interest rate to fall.  [People like to keep optimal proportions of
money and bonds in their portfolios; if money is increased, then people try to re-attain their
optimal proportions by “exchanging” some of the money for bonds:  they use some of the extra money
to buy bonds.  This increase in the demand for bonds drives up the price of bonds -- and causes
interest rates to fall (since interest rates are inversely related to bond prices).
   The fall in the interest rate induces an increase in investment demand, which causes output and
income to increase.
   The increase in income causes money demand to increase, which increases the interest rate
(though doesn’t increase it all the way back to its initial value; instead, this effect simply
reduces the total decrease in the interest rate).

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Interaction between
monetary & fiscal policy
§Model:
Monetary & fiscal policy variables
(M, G, and T ) are exogenous.
§Real world:
Monetary policymakers may adjust M
in response to changes in fiscal policy,
or vice versa.
§Such interaction may alter the impact of the original policy change.

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
The Fed’s response to  DG  > 0
§Suppose Congress increases G.
§Possible Fed responses:
§1.  hold M  constant
§2.  hold r  constant
§3.  hold Y  constant
§In each case, the effects of the DG
are different:

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
If Congress raises G,
the IS curve shifts right.
IS1
Response 1:   Hold M  constant
Y
r
LM1
r1
Y1
IS2
Y2
r2
If Fed holds M constant, then LM curve doesn’t shift.
Results:

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
If Congress raises G,
the IS curve shifts right.
IS1
Response 2:   Hold r  constant
Y
r
LM1
r1
Y1
IS2
Y2
r2
To keep r constant, Fed increases M
to shift LM curve right.
LM2
Y3
Results:

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
IS1
Response 3:   Hold Y  constant
Y
r
LM1
r1
IS2
Y2
r2
To keep Y constant, Fed reduces M
to shift LM curve left.
LM2
Results:
Y1
r3
If Congress raises G,
the IS curve shifts right.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Estimates of fiscal policy multipliers
§from the DRI macroeconometric model
Assumption about monetary policy
Estimated value of
DY / DG
Fed holds nominal interest rate constant
Fed holds money supply constant
1.93
0.60
Estimated value of
DY / DT
-1.19
-0.26

The preceding slides show that the impact of fiscal policy on GDP depends on the Fed’s response (or
lack thereof).  This slide shows estimates of the fiscal policy multipliers under different
assumptions about monetary policy; these estimates are consistent with the theoretical results on
the preceding slides.
First, the slide shows estimates of the government spending multiplier for the two different
monetary policy scenarios.  Then, the slide reveals the tax multiplier estimates.  (If you wish,
you can turn off the animation so that everything appearing on the slide appears at one time.  Just
click on the “Slide Show” pull-down menu, then on “Custom animation…”, then uncheck all of the
boxes next to the elements of the screen that you do not wish to be animated.
Regarding the estimates:  First, note that the estimates of the fiscal policy multipliers are
smaller (in absolute value) when the money supply is held constant than when the interest rate is
held constant.  This is consistent with the results from the IS-LM model presented in the preceding
few slides.
Second, notice that the tax multiplier is smaller than the government spending multiplier in each
of the monetary policy scenarios.  This should make sense from material presented earlier in this
chapter:  the government spending multiplier (for a constant money supply) is 1/(1-MPC), while the
tax multiplier is only (-MPC)/(1-MPC).

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Shocks in the IS -LM model
§IS shocks:  exogenous changes in the demand for goods & services.
§Examples:
§stock market boom or crash
Þ change in households’ wealth
Þ DC
§change in business or consumer
confidence or expectations
  Þ DI  and/or DC

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Shocks in the IS -LM model
§LM shocks:  exogenous changes in the demand for money.
§Examples:
§a wave of credit card fraud increases demand for money.
§more ATMs or the Internet reduce money demand.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
EXERCISE:
Analyze shocks with the IS-LM model
§Use the IS-LM model to analyze the effects of
§1. a boom in the stock market that makes consumers wealthier.
§2. after a wave of credit card fraud, consumers using cash more frequently in transactions.
§For each shock,
§a. use the IS-LM diagram to show the effects of the shock on Y and r.
§b. determine what happens to C, I, and the unemployment rate.

>

Earlier slides showed how to use the IS-LM model to analyze fiscal and monetary policy.  Now is a
good time for students to get some hands-on practice with the model.  Also, note that part (b)
helps students learn that shocks and policies can potentially affect all of the model’s endogenous
variables, not just the ones that are measured on the axes.
After working this exercise, your students will better understand the case study on the 2001 U.S.
recession that immediately follows.
Suggestion:  Instead of having students work on these exercises individually, get them into pairs.
One student of each pair works on the first shock, the other student works on the second shock.
Give them 5 minutes to work individually on the analysis of the shock.  Then, allow 10 minutes (5
for each student) for students to present their results to their partners.   This activity gives
students immediate application and reinforcement of the concepts, so students learn them better and
will then better understand and appreciate the remainder of your lecture on Chapter 11.
                                             Answers:
1a.  The IS curve shifts to the right, because consumers feel they can afford to spend more given
this exogenous increase in their wealth.  This causes Y and r to rise.
1b.  C  rises for two reasons:  the stock market boom, and the increase in income.  I  falls,
because r is higher.  u  falls, because firms hire more workers to produce the extra output that is
demanded.
2a. (This is a continuation of the in-class exercise at the end of the PowerPoint presentation of
Chapter 10.)  The increase in money demand shifts the LM curve to the left:  We are assuming that
all other exogenous variables, including M and P, remain unchanged, so an increase in money demand
causes an increase in the value of r associated with each value of Y (this can be seen easily using
the Liquidity Preference diagram).  This translates to an upward (i.e. leftward) shift in the LM
curve.   This shift causes Y to fall and r to rise.
2b.  The fall in income causes a fall in C.  The increase in r causes a fall in I.  The fall in Y
causes an increase in u.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
CASE STUDY:
The U.S. recession of 2001
§During 2001,
§2.1 million people lost their jobs,
as unemployment rose from 3.9% to 5.8%.
§GDP growth slowed to 0.8%
(compared to 3.9% average annual growth during 1994-2000).
§

If you taught with the PowerPoints I did for the previous (orange) edition of this book, you will
find that I have redone this case study.  In addition to updating it to match the textbook, I have
added two time-series graphs showing stock prices and the effects of the Fed’s policy response on
short-term interest rates.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
CASE STUDY:
The U.S. recession of 2001
§Causes:  1)  Stock market decline  Þ  ¯C
300
600
900
1200
1500
1995
1996
1997
1998
1999
2000
2001
2002
2003
Standard & Poor’s 500

Starting in mid-2000, the S&P 500 begins a downward trend.  The fall in stock prices eroded the
wealth of millions of U.S. consumers.  They responded by reducing consumption.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
CASE STUDY:
The U.S. recession of 2001
§Causes:  2)  9/11
§increased uncertainty
§fall in consumer & business confidence
§result:  lower spending, IS  curve shifted left
§Causes:  3)  Corporate accounting scandals
§Enron, WorldCom, etc.
§reduced stock prices, discouraged investment
§

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
CASE STUDY:
The U.S. recession of 2001
§Fiscal policy response:   shifted IS  curve right
§tax cuts in 2001 and 2003
§spending increases
§airline industry bailout
§NYC reconstruction
§Afghanistan war
§

The war was a response to the 9/11 attacks, not to the recession.  But wars involve significant
fiscal policy expansion, which increases aggregate demand and alleviates or ends recessions.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
CASE STUDY:
The U.S. recession of 2001
§Monetary policy response:   shifted LM  curve right
Three-month T-Bill Rate
0
1
2
3
4
5
6
7

Easier monetary policy shifted the LM curve to the right, causing interest rates to fall, as shown
in this graph.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
What is the Fed’s policy instrument?
§The news media commonly report the Fed’s policy changes as interest rate changes, as if the Fed
has direct control over market interest rates.
§In fact, the Fed targets the federal funds rate – the interest rate banks charge one another on
overnight loans.
§The Fed changes the money supply and shifts the LM curve to achieve its target.
§Other short-term rates typically move with the federal funds rate.

>

Chapter 18 discusses monetary policy in detail.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
What is the Fed’s policy instrument?
§Why does the Fed target interest rates instead of the money supply?
§1) They are easier to measure than the money supply.
§2) The Fed might believe that LM shocks are more prevalent than IS shocks.  If so, then targeting
the interest rate stabilizes income better than targeting the money supply.
(See end-of-chapter Problem 7 on p.328.)

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
IS-LM and aggregate demand
§So far, we’ve been using the IS-LM  model to analyze the short run, when the price level is
assumed fixed.
§However, a change in P  would
shift LM and therefore affect Y.
§The aggregate demand curve
(introduced in Chap. 9) captures this
relationship between P and Y.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Y1
Y2
Deriving the AD curve
Y
r
Y
P
IS
LM(P1)
LM(P2)
AD
P1
P2
Y2
Y1
r2
r1
Intuition for slope
of AD curve:
P  Þ ¯(M/P )
Þ LM shifts left
Þ r
Þ ¯I
Þ ¯Y

It might be useful to explain to students the reason why we draw P[1] before drawing the LM curve:
The position of the LM curve depends on the value of M/P.  M is an exogenous policy variable.  So,
if P is low (like P[1] in the lower panel of the diagram), then M/P is relatively high, so the LM
curve is over toward the right in the upper diagram.  If P is high, like P[2], then M/P is
relatively low, so the LM curve is more toward the left.
Because the value of P affects the position of the LM curve, we label the LM curves in the upper
panel as LM(P[1]) and LM(P[2]).

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Monetary policy and the AD curve
Y
P
IS
LM(M2/P1)
LM(M1/P1)
AD1
P1
Y1
Y1
Y2
Y2
r1
r2
The Fed can increase aggregate demand:
M  Þ LM shifts right
AD2
Y
r
Þ ¯r
Þ I
Þ Y  at each         value of P

It’s worth taking a moment to explain why we are holding P fixed at P[1]:
To find out whether the AD curve shifts to the left or right, we need to find out what happens to
the value of Y associated with any given value of P.  This is not to say that the equilibrium value
of P will remain fixed after the policy change (though, in fact, we are assuming P is fixed in the
short run).  We just want to see what happens to the AD curve.
Once we know how the AD curve shifts, we can then add the AS curves (short- or long-run) to find
out what, if anything, happens to P (in the short- or long-run).

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Y2
Y2
r2
Y1
Y1
r1
Fiscal policy and the AD curve
Y
r
Y
P
IS1
LM
AD1
P1
Expansionary fiscal policy (G  and/or ¯T ) increases agg. demand:
¯T  Þ C
Þ IS shifts right
Þ Y  at each value of P
AD2
IS2

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
IS-LM and AD-AS
in the short run & long run
§Recall from Chapter 9:    The force that moves the economy from the short run to the long run
is the gradual adjustment of prices.
rise
fall
remain constant
In the short-run equilibrium, if
then over time, the price level will

The next few slides put our IS-LM-AD in the context of the bigger picture - the AD-AS model in the
short-run and long-run, which was introduced in Chapter 9.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
The SR and LR effects of an IS shock
§A negative IS shock shifts IS and AD left, causing Y  to fall.
Y
r
Y
P
LRAS
LRAS
IS1
SRAS1
P1
LM(P1)
IS2
AD2
AD1

Abbreviation:
   SR = short run, LR = long run
The analysis that begins on this slide continues on the following slides.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
The SR and LR effects of an IS shock
Y
r
Y
P
LRAS
LRAS
IS1
SRAS1
P1
LM(P1)
IS2
AD2
AD1
In the new short-run equilibrium,

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
The SR and LR effects of an IS shock
Y
r
Y
P
LRAS
LRAS
IS1
SRAS1
P1
LM(P1)
IS2
AD2
AD1
In the new short-run equilibrium,
Over time, P gradually falls, which causes
•SRAS  to move down.
•M/P  to increase, which causes LM
to move down.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
AD2
The SR and LR effects of an IS shock
Y
r
Y
P
LRAS
LRAS
IS1
SRAS1
P1
LM(P1)
IS2
AD1
SRAS2
P2
LM(P2)
Over time, P gradually falls, which causes
•SRAS  to move down.
•M/P  to increase, which causes LM
to move down.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
AD2
SRAS2
P2
LM(P2)
The SR and LR effects of an IS shock
Y
r
Y
P
LRAS
LRAS
IS1
SRAS1
P1
LM(P1)
IS2
AD1
This process continues until economy reaches a long-run equilibrium with

A good thing to do:  Go back through this experiment again, and see if your students can figure out
what is happening to the other endogenous variables (C, I, u) in the short run and long run.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
EXERCISE:
Analyze SR & LR effects of DM
a.Draw the IS-LM and AD-AS diagrams as shown here.
b.Suppose Fed increases M.  Show the short-run effects on your graphs.
c.Show what happens in the transition from the short run to the long run.
d.How do the new long-run equilibrium values of the endogenous variables compare to their initial
values?
Y
r
Y
P
LRAS
LRAS
IS
SRAS1
P1
LM(M1/P1)
AD1

This exercise has two objectives:
1.  To give students immediate reinforcement of the preceding concepts.
2.  To show them that money is neutral in the long run, just like in chapter 4.
You might have your students try other exercises using this framework:
* the short-run and long-run effects of expansionary fiscal policy.  Have them compare the long-run
results in this framework with the results they obtained when doing the same experiment in Chapter
3 (the loanable funds model).
* Immediately after a negative shock pushes output below its natural rate, show how monetary or
fiscal policy can be used to restore full-employment immediately (i.e., without waiting for prices
to adjust).

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
The Great Depression
Unemployment (right scale)
Real GNP
(left scale)
120
140
160
180
200
220
240
1929
1931
1933
1935
1937
1939
0
5
10
15
20
25
30

This chart presents data from Table 11-2 on pp.318-9 of the text.  For data sources, see notes
accompanying that table.
Things to note:
1.  The magnitude of the fall in output and increase in unemployment.  In 1933, the unemployment
rate is over 25%!!
2.  There’s a very strong negative correlation between output and unemployment.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE SPENDING HYPOTHESIS:
Shocks to the IS curve
§asserts that the Depression was largely due to an exogenous fall in the demand for goods &
services – a leftward shift of the IS curve.
§evidence:
output and interest rates both fell, which is what a leftward IS shift would cause.

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE SPENDING HYPOTHESIS:
Reasons for the IS shift
§Stock market crash Þ exogenous ¯C
§Oct-Dec 1929:  S&P 500 fell 17%
§Oct 1929-Dec 1933:  S&P 500 fell 71%
§Drop in investment
§“correction” after overbuilding in the 1920s
§widespread bank failures made it harder to obtain financing for investment
§Contractionary fiscal policy
§Politicians raised tax rates and cut spending to combat increasing deficits.

>

In item 2, I’m using the term “correction” in the stock market sense.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE MONEY HYPOTHESIS:
A shock to the LM curve
§asserts that the Depression was largely due to huge fall in the money supply.
§evidence:
M1 fell 25% during 1929-33.
§But, two problems with this hypothesis:
§P  fell even more, so M/P  actually rose slightly during 1929-31.
§nominal interest rates fell, which is the opposite of what a leftward LM shift would cause.

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices
§asserts that the severity of the Depression was due to a huge deflation:
P fell 25% during 1929-33.
§This deflation was probably caused by the fall in M, so perhaps money played an important role
after all.
§In what ways does a deflation affect the economy?

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices
§The stabilizing effects of deflation:
§¯P Þ (M/P ) Þ LM  shifts right Þ Y
§Pigou effect:
§ ¯P Þ (M/P )
§ Þ consumers’ wealth
§ Þ C
§ Þ IS shifts right
§ Þ Y

>

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices
§The destabilizing effects of expected deflation:
§     ¯p e
§Þ r    for each value of i
§Þ I ¯   because I  = I (r )
§Þ planned expenditure & agg. demand ¯
§Þ income & output ¯
§

>

The textbook (starting p.322) uses an “extended”
IS-LM model, which includes both the nominal interest rate (measured on the vertical axis) and the
real interest rate (which equals the nominal rate less expected inflation).  Because money demand
depends on the nominal rate, which is measured on the vertical axis, the change in expected
inflation doesn’t shift the LM curve.  However, investment depends on the real interest rate, so
the fall in expected inflation shifts the IS curve:  each value of i is now associated with a
higher value of r, which reduces investment and shifts the IS curve to the left.  Results:  income
falls, i  falls, and r rises --- which is exactly what happened from 1929 to 1931 (see table 11-2
on pp.318-9).
This slide gives the basic intuition, which students often can grasp more quickly and easily than
the graphical analysis.  After you cover this material in your lecture, it will be easier for your
students to grasp the analysis on pp.322-23.

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
THE MONEY HYPOTHESIS AGAIN:
The effects of falling prices
§The destabilizing effects of unexpected deflation:
debt-deflation theory
§¯P (if unexpected)
§Þ transfers purchasing power from borrowers to lenders
§Þ borrowers spend less,
lenders spend more
§Þ if borrowers’ propensity to spend is larger than lenders’, then aggregate spending falls,
the IS curve shifts left, and Y falls

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CHAPTER 11   Aggregate Demand II
CHAPTER 11   Aggregate Demand II
Why another Depression is unlikely
§Policymakers (or their advisors) now know
much more about macroeconomics:
§The Fed knows better than to let M  fall
so much, especially during a contraction.
§Fiscal policymakers know better than to raise taxes or cut spending during a contraction.
§Federal deposit insurance makes widespread bank failures very unlikely.
§Automatic stabilizers make fiscal policy expansionary during an economic downturn.

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Examples of automatic stabilizers:
•the income tax:  people pay less taxes automatically if their income falls
•unemployment insurance:  prevents income - and hence spending - from falling as much during a
downturn
This topic is discussed in Chapter 14.

Chapter Summary
§ 1.  IS-LM model
§a theory of aggregate demand
§exogenous:  M, G, T,
  P  exogenous in short run, Y  in long run
§endogenous:  r,
 Y  endogenous in short run, P  in long run
§IS  curve:  goods market equilibrium
§LM  curve:  money market equilibrium
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Chapter Summary
§ 2. AD curve
§shows relation between P  and the IS-LM  model’s equilibrium Y.
§negative slope because
P  Þ ¯(M/P ) Þ r  Þ ¯I  Þ ¯Y
§expansionary fiscal policy shifts IS  curve right, raises income, and shifts AD curve right.
§expansionary monetary policy shifts LM  curve right, raises income, and shifts AD curve right.
§IS  or LM  shocks shift the AD  curve.
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