İ discussed on explanation
Explanation:
The IS-LM model reflects the balance between interest rates and production volumes in commodity and money markets. The name of this model comes from the combination of 2 basic economic equilibrium: Investment in economy (I) should be equal to savings (C) and money demand (L) equals money supply (M). This model shows that commodity and money markets are balanced. In the IS curve, investment (expressed as interest rate) is equal to accumulation (issued as production). The IS curve is low due to the fact that there is a balance between interest rates and production in the commodity market. As the production grows, more money is invested, and the interest rate is lower so that investment is equal. Since the interest rate and production in the money market are directly proportional, the LM curve is high. As production increases, demand for money grows and interest rates increase.
Impact of fiscal policy on the IS curve
The IS curve represents the level of income that balances the commodity and services market at a given interest rate. But the income level also depends on government spending and taxes. The IS curve is drawn for a stable fiscal policy. That is, public expenditures and taxes are stable. When the fiscal policy changes, the IS curve changes its place. As an increase in public spending, the IS curve shifts its position (to the right). A reduction in taxes also causes the IS curve to slip.
Impact of monetary policy on the LM curve
The LM curve defines the interest rate that balances the money market for the given income level. But as mentioned earlier, the rate of interest depends on the supply of the real money at the same time. If the real money balance changes, such as the Central Bank's money supply, the LM curve shifts The liquidity preference theory should be used to understand how changes in monetary policy move the LM curve. Assume that the Central Bank has reduced money demand from M1 to M2. This will lead to a drop in the real money balance supply. When the income level and indirect demand for money are stable, the decline in the money supply raises the interest rate that balances the market. Thus, the LM curve moves to the left. As a result, the increase in real money supply suggests that the LM curve shifts to the right and the decrease to the left.
Fiscal Policy
In economics and political science, fiscal policy is used to influence the economy through government revenues and expenditures. According to the Keines School of Economics, when the state changes the level (level) and costs of taxes, it affects student and economic activity. Fiscal policy is applied to stabilize the economy when changes in business cycles occur. When the two main instruments of fiscal policy change taxes and public expenditure, it affects the following macroeconomic indicators:
Total demand and level of economic activity;
Savings and investments;
Distribution of Income.
Fiscal policy differs from monetary policy by some characteristics. Thus, fiscal policy affects the economy through changes in government revenues and expenditures regulated by the legislative act. Monetary policy is implemented by the central bank by influencing money supply, interest rates and obligatory reserve requirements.
There are three main types of fiscal policy:
1) Neutral fiscal policy is usually applied when the economy reaches a balance. At the same time, public expenditures are fully funded by government revenues and have a neutral impact on the economy.
2) Expanding fiscal policy outpaces public spending. This policy is usually implemented in times of crisis.
3) If a fiscal policy is implemented, only a portion of government revenues will be expensed. The remaining part will be used to repay domestic or foreign debts.
Monetary Policy
In monetary policy, the economy is governed and regulated by money and its instruments. This policy is based on the impact of interest rates on the economy and changes the cost of borrowing and the aggregate supply of money. Monetary policy uses a variety of tools to manage them, which has an impact on economic growth, inflation, unemployment and the exchange rate. Thus, monetary policy (money for economic purposes) manages money supply and interest rates, if the issue of currency is carried out from one center or there is a system of regulated banks providing money for economic entities.
Types of monetary policy
1) In the case of aggressive policy, money supply will be reduced or increased or interest rate raised.
2) In the case of expansionary policy, money supply will either increase or decrease interest rates.
3) Soft monetary policy. The central bank lowers interest rates and stimulates economic growth
4) Neutral monetary policy. The central bank does not change interest rates. Thus, neither economic growth is encouraged nor inflation.
5) Strict monetary policy. At the same time inflation is reduced while keeping interest rates high.
