 Good morning, good afternoon, good evening, depending on where you are. Today we want to discuss macroeconomic policy, physical policy, monetary policy. And what I find the most exciting to me in macroeconomics courses is the ability to actually understand how government authorities implement monetary and physical policy and how their actions affect the economy. So for example, today we are facing a situation where countries are struggling to overcome the impact of the crisis. And one of the things that governments try to do is to use monetary policy and fiscal policy to help to stimulate the economy through monetary policy and fiscal policy. But at the same time also the governments find themselves in very difficult conditions where they also have to watch spending so that the budget deficit doesn't go out of control because that also can create its own problems. So we can look at, for example, if government is constrained to reduce the deficit by through monetary through fiscal policy, what kind of impact will that have on the economy? Or if the government feels that the economy needs a little bit of stimulus and push and decides to implement an expansionary monetary policy, to use monetary policy to stimulate the economy, how does it work? What kind of tools can we use to understand that? So our starting point is really understanding the equilibrium in the economy as a whole. As we have seen already, one way to do that is to look at how different markets reach equilibrium, the goods market, the money market. And then from there the objective of the policy analysis is to see from a given equilibrium, if the government decides to intervene, say through contractual fiscal policy by reducing government expenditures or increasing taxation, how would that affect the equilibrium in the economy? And then we'll try to understand why we go from one point to another once the policy has taken its course and we achieve a new equilibrium. So the starting point, as I said, is the equilibrium conditions in the economy. So we have seen that we can characterize the equilibrium in the economy by looking at different markets, the goods market, the goods market, and the money market. In terms of the goods market, as we saw, the equilibrium is when the demand for goods and services is equal to output. So demand represented by this Z zero line must be equal to output, which we call Y. So in a condition, in a point like this one, we have equilibrium when output is equal to Y zero. Now, for us to examine the impact of fiscal policy, monetary policy in the economy, we need to bring all these markets together. So for the money market, again, the equilibrium was determined by when money supply is equal to money demand. So for example, here we start with money demand being at this level, money supply at this level. We have equilibrium money stock here and the interest rate. But what happens when we move from, say, this point Y zero to a point Y one? In the context of the goods market, the key relationship in the context of the goods market is the relationship between, is the investment. Investment is our key variable that we're going to watch. So investment, we're going to say that investment depends on output and interest rate. The higher the output, the higher the investment. So it's a positive relationship. For interest rate, the higher the interest rate, the lower the output, the lower the investment. So it's a negative relationship. For the money market, the key relationship will be the money demand, money demand function, which we have already seen. So money demand, in real terms, we say it's proportional to output and it's a function of the interest rate. The higher the income, the higher the money demand. The higher the interest rate, the lower the money demand. So money demand a function of income and interest rate, investment a function of output and our income and interest rate. So that allows us to derive a set of equilibrium conditions in the good market. So for all levels of interest rate, we can find the corresponding levels of income. So for example, if we start with this position where interest rate is equal to i0, output or income is y0, and suppose the interest rate goes up, suppose the Fed raises interest rate, what would happen to output? Then we go here. If interest rate is higher, moves from say i0 to i1, the higher level of interest rate, what happens to investment? Investment being negatively related to interest rate would decline. So a higher interest rate would reduce investment. Now remember, investment is part of aggregate demand. Investment is part of aggregate demand, that z. So z was equal to consumption, investment, and government expenditures. Now if we're saying that there is a higher interest rate, reducing investment, this means that this goes down. So investment goes down, that means that aggregate demand is going to go down. So this line is going to shift down because of the increase in interest rate. But then we see that the new equilibrium is no longer here, but is there. So the higher interest rate now corresponds to lower income. So we have a new equilibrium point. If we keep raising interest rate, we do choose a higher interest rate again, it will have a lower income. So we see that in the goods market, there is a negative relationship between output and interest rate along this line. Along this line, there is a negative relationship between interest rate and income. This set of equilibrium conditions in the goods market, where we have a combination of income and interest rate giving us equilibrium in the goods market gives us this curve, which we call the IS curve, investment saving curve, because the key here is the investment. And in a good market, we have equilibrium when investment is equal to savings. Everybody remembers that. So the IS curve gives us the set of conditions for equilibrium in the goods market. How about the money market? For the money market, we have equilibrium when money demand is equal to money supply. Money demand is equal to money supply, so it would be at a point like this. So we have money demand equals to money supply. But then what would happen if income rises? What happens if income rises in this money market? So we're starting with a position where we are here at this interest rate. Output is equal to Y0. But then I'm asking what happens if say output rises to Y1? What would happen? If output rises to Y1, then we have to see how does this get affected? We said money demand is a positive function of output, negative function of interest. But now we are concerned about the impact of a higher output on money demand. If output is higher, then money demand is higher. Remember income being higher means that people are going to demand more money for transactions. It means they're going to buy more goods and services because they have more income, so that raises money demand. So money demand is going to increase. So this curve moves to a higher level, and now we get settled to a higher interest rate. So as income rows, interest rate rows because money demand shifted to a higher level. So now we have a new interest rate corresponding to this new higher income gives us this new equilibrium condition. So in this case, we have that higher output corresponds to a higher interest rate, a positive relationship, which we're going to call the LM curve for liquidity and money. So in the money market, we have higher output leading to lower interest rate. In the goods market, we have higher interest rate corresponding to lower output. So now we're going to use our two key relationships that we'll be using in our analysis. The IS curve, the LM curve, the IS curve giving us the set of conditions for equilibrium in the goods market, giving us levels of output and interest rates so that when the goods market is in equilibrium, and then the LM giving us the set of conditions for output and interest rate giving us equilibrium in the money market. So this is what we're going to use in our analysis of monetary and fiscal policy, the IS LM system. So we're going to use the IS LM framework to examine the condition, the impact of monetary policy and fiscal policy in any given country. Okay, so we're going to assume the government, for example, is willing to stimulate the economy in some conditions that may be willing to slow down the economy if the economy seems to be overheating. And then we'll see how this affects equilibrium, output and interest rate. Thank you. Good evening, good afternoon, good morning.