Lecture slides for an undergraduate course on Basic Macroeconomics that I taught in the Fall of 2007. This lecture describes the interaction between the goods and money markets.

1. Fiscal and monetary policy
Goods and Money Market Equilibrium and the Real Economy

2. The Story So Far (Yet Again)
• We know that the economy is in equilibrium when Y = AE.
• There is a level of output for which income is equal to
planned aggregate expenditure.
• The components of planned aggregate expenditure are
consumption, investment, and government spending.
• Fiscal policy involves control over government spending
and taxation, which has an effect on Y in the goods market.
• Monetary policy involves control over the money supply,
which has an effect on r in the money market.
Y = C + I + G + (X – M) . . . but this time, with monetary and fiscal policy.

3. There is a level of ouput or income (Y) and
an interest rate (r) that represents an
equilibrium in both markets.
There is a level of ouput or income (Y) and
an interest rate (r) that represents an
equilibrium in both markets.
There is a level of ouput or income (Y) and
an interest rate (r) that represents an
equilibrium in both markets.
The Real EconomyBringing together the goods market and money market.

4. But First...
• The goods and money markets are related as follows:
• The goods market determines income, which affects the
demand for money.
• The money market determines the interest rate, which
affects the level of investment.
• Government policies toward the goods and money markets
can be either expansionary or contractionary.
How the goods and money markets are related.
Fiscal Policy
Monetary Policy
Expansionary
↑ G or ↓ T
↑ Money Supply
Contractionary
↓ G or ↑ T
↓ Money Supply

5. The Policy MixHow fiscal and monetary policies interact.
Fiscal Policy
Expansionary
(↑ G or ↓ T )
Contractionary
(↓ G or ↑ T)
Monetary
Policy
Expansionary
(↑ Money Suppply)
Contractionary
(↓ Money Suppply)

6. Case 1Expansionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

7. Case 1Expansionary Fiscal and Monetary Policies.
AE
Y
45º
AE
r
M
s
M
s
M
d

8. Case 1Expansionary Fiscal and Monetary Policies.
AE
Y
45º
AE
r
M
s
M
s
M
d

9. Case 1Expansionary Fiscal and Monetary Policies.
AE
Y
45º
r
M
s
M
s
M
d
AE

10. Case 1Expansionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

11. Case 1Expansionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

12. Case 1Expansionary Fiscal and Monetary Policies.
r
M
s
M
s
M
d
AE
Y
45º
AE

13. The Policy MixHow fiscal and monetary policies interact.
Fiscal Policy
Expansionary
(↑ G or ↓ T )
Contractionary
(↓ G or ↑ T)
Monetary
Policy
Expansionary
(↑ Money Suppply)
Y↑, AE↑, r?, I?
Contractionary
(↓ Money Suppply)

14. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
AE
Y
45º
r
M
s
M
s
M
d
AE

15. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
AE
Y
45º
r
M
s
M
s
M
d
AE

16. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
r
M
s
M
s
M
d
AE
Y
45º
AE

17. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
r
M
s
M
s
M
d
AE
Y
45º
AE

18. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
AE
Y
45º
r
M
s
AE
M
s
M
d

19. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
AE
Y
r
M
s
45º
M
s
M
d
AE

20. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
AE
Y
r
M
s
45º
M
s
M
d
AE

21. Case 2Contractionary Fiscal Policy and Expansionary Monetary Policy.
AE
Y
r
M
s
45º
M
s
M
d
AE

22. The Policy MixHow fiscal and monetary policies interact.
Fiscal Policy
Expansionary
(↑ G or ↓ T )
Contractionary
(↓ G or ↑ T)
Monetary
Policy
Expansionary
(↑ Money Suppply)
Y↑, AE↑, r?, I? Y?, AE?, r↓, I↑
Contractionary
(↓ Money Suppply)

23. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
r
M
s
45º
M
s
M
d
AE

24. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
45º
r
M
s
M
s
M
d
AE

25. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
45º
r
M
s
M
s
M
d
AE

26. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
45º
r
M
s
M
s
M
d
AE

27. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
r
M
s
45º
M
s
M
d
AE

28. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
r
M
s
45º
M
d
AE
M
s

29. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
r
M
s
45º
M
d
AE
M
s

30. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
r
M
s
45º
M
d
AE
M
s

31. Case 3Expansionary Fiscal Policy and Contractionary Monetary Policy.
AE
Y
r
M
s
45º
M
d
M
s
AE

32. The Policy MixHow fiscal and monetary policies interact.
Fiscal Policy
Expansionary
(↑ G or ↓ T )
Contractionary
(↓ G or ↑ T)
Monetary
Policy
Expansionary
(↑ Money Suppply)
Y↑, AE↑, r?, I? Y?, AE?, r↓, I↑
Contractionary
(↓ Money Suppply)
Y?, AE?, r↑, I↓

33. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
AE
M
s
M
d

34. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

35. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

36. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

37. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
s
M
d
AE

38. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
d
AE
M
s

39. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
d
AE
M
s

40. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
d
AE
M
s

41. Case 4Contractionary Fiscal and Monetary Policies.
AE
Y
r
M
s
45º
M
d
M
s
AE

42. The Policy MixHow fiscal and monetary policies interact.
Fiscal Policy
Expansionary
(↑ G or ↓ T )
Contractionary
(↓ G or ↑ T)
Monetary
Policy
Expansionary
(↑ Money Suppply)
Y↑, AE↑, r?, I? Y?, AE?, r↓, I↑
Contractionary
(↓ Money Suppply)
Y?, AE?, r↑, I↓ Y↓, AE↓, r?, I?

43. There is a level of ouput or income (Y) and
an interest rate (r) that represents an
equilibrium in both markets.
There is a level of ouput or income (Y) and
an interest rate (r) that represents an
equilibrium in both markets.
There is a level of ouput or income (Y) and
an interest rate (r) that represents an
equilibrium in both markets.
The Real EconomyBringing together the goods market and money market.

44. IS-LM AnalysisAnother way to depict goods and money market equilibrium.
r
Y
LM
IS
The LM Curve depicts various
interest rates at which the
money market is in equilibrium
for a given level of income.
The IS Curve depicts various
interest rates at which the
goods market is in equilibrium
for a given level of income.

45. IS-LM AnalysisAnother way to depict goods and money market equilibrium.
Y
r
LM
IS
If both fiscal and monetary
policies are expansionary,
output clearly increases.
Presumably so does AE.
However, we cannot say
what happens to the interest
rate or investment without
knowing the relative
magnitude of each policy.

46. IS-LM AnalysisAnother way to depict goods and money market equilibrium.
r
Y
LM
IS
If monetary policy is
expansionary, the LM curve
shifts outward.
If fiscal policy is
contractionary, the IS curve
shifts inward.
The interest rate declines,
meaning that investments
must rise.
The relative magnitude of
each policy determines
what happens to Y and AE.