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Using the IS - MP model, explain the effects of a monetary expansion combined with a fiscal
contraction. How do the equilibrium level of output and interest rate change?
Answer: The monetary expansion shifts the LM curve to the right which by itself would cause
the interest rate to decrease and aggregate output to increase. The fiscal contraction shifts the IS
curve to the left which by itself would cause the interest rate to decrease and aggregate output to
decrease. Therefore, the equilibrium interest rate unambiguously falls, while the effect on output
is indeterminate.
Diff: 2 Type: SA Page Ref: 566
Skill: Recall
Objective List: 23.1 Apply the IS-MP framework for the determination of aggregate output and
the interest rate
List the six factors that cause both the IS and the aggregate demand curve to shift.
Answer:
- Autonomous consumption expenditure
- Autonomous investment spending
- Government purchases
- Taxes
- Autonomous net exports
- Financial frictions.
Diff: 2 Type: SA Page Ref: 564
Skill: Recall
Objective List: 23.1 Apply the IS-MP framework for the determination of aggregate output and
the interest rate
How does autonomous tightening of monetary policy impact the aggregate demand curve.
Answer: A rise in the real interest rate at any given inflation, shifts the monetary policy curve
upward. The higher interest rates leads to lower output due to a decline in investment and net
exports which lowers aggregate output and therefore the aggregate demand curve to the left.
Diff: 2 Type: SA Page Ref: 568 - 569
Skill: Recall
Objective List: 23.1 Apply the IS-MP framework for the determination of aggregate output and
the interest rate
Describe non-conventional policies that could be implemented by the Bank of Canada when
the policy rate approaches the lower bound.
Answer: The central bank could use forward guidance, quantitative easing and credit easing.
Diff: 2 Type: SA Page Ref: 567
Skill: Recall
Objective List: 23.1 Apply the IS-MP framework for the determination of aggregate output and
the interest rate