Professional Documents
Culture Documents
Session 11
1
A rise in G by printing Money (Deficit Financing)
r
LM
LM (new)
r*
IS(new)
IS
Y*
Rise in G causes a rightward shift in IS.
Borrowing from the Central Bank increases the supply of real
balances →The LM shifts downwards.
More supply of real balances reduces r as people try to convert the excess
balances into bonds. Bond prices rise, interest rate falls. For all Y, r is lower.
2
What Happens in this Case?
IS3
A rise in M shifts
LM to the right
Liquidity Trap
IS2
IS1
Y
If IS1 then no change in income and interest rate
If IS2 then only income increases (r falls) 4
Effective Policy in Liquidity Trap
5
Effective Policy in Liquidity Trap
6
Effective Policy in Liquidity Trap