IS/MP model

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The IS/MP model (Investment—Savings / Monetary—Policy) is a macroeconomic tool which displays short-run fluctuations in the interest rate, inflation and output.[1]

Formation[edit]

MP Curve[edit]

The MP curve displays a positive relationship, upward sloping curve, where the real interest rate is located on the horizontal axis and inflation on the vertical axis.

Shifts on the MP curve are produced by actions of the Federal Reserve. So, a target decrease in the federal funds rate, \overline i, shifts the MP curve to the left, which results in a decrease in the real interest rate and an increase in the inflation rate.

IS curve[edit]

An increase in the interest rate, from a right shift of the MP curve or higher level of inflation, produces lower total output, Q.

The IS curve displays a negative relationship between the real interest rate, located on the vertical axis, and total output, on the horizontal axis.

Shifts on the IS curve are produced by actions of the government and consumers. For example, an increase in either consumer or government spending shifts the IS curve right, resulting in an increase in total output for any level of the interest rate.

Analysis[edit]

Example: A lowering of the fund funds target would shift the MP curve left, resulting in a lower interest rate, and higher inflation. This lower interest rate results in a downward movement along the IS curve, increased output.

Incorporation into larger models[edit]

The IS/MP model is used as a foundation for the AD–AS model. When used within the AD-AS framework we may derive long-term movements in inflation and interest rates, rather than base, short-run movements.

Criticism[edit]

Greg Mankiw maintains the IS/MP model has "quirky features". Mankiw prefers the IS/LM model, for, according to him, it focuses on "important connections between the money supply, interest rates, and economic activity, whereas the IS-MP model leaves some of that in the background." [2]

References[edit]

  1. ^ Romer, David (2000). "Keynesian Macroeconomics without the LM Curve". Journal of Economic Perspectives 14 (2): 149–169. doi:10.1257/jep.14.2.149. JSTOR 2647100. 
  2. ^ "The IS-LM Model". May 30, 2006.