Dynamic Higher Education Thesis

Chapter 5: The goods and Financial Markets

Tommaso Iannaccone, Rim Guessous, Simin Izgoren, Patricio Gutierrez, Nikoloz Kobelia, Martina Giroldi, Etienne Leon, Sofiya Karsakova, Maria de los Santos, and Maria Jaramillo

XX/XX/20XX

01

Using Suno AI

“Create an upbeat and catchy song about IS-LM equilibrium. It should have terms as interest rate, output, and policy mix. ”

01

How does a contractionary policy mix affect different regions within a single country, particularly in economies with significant regional disparities? Keep the answer to two paragraphs and relate it to my country of origin, Italy.

Prompt 2 Contractionary policy mix

• Concise Explanation
• Structured Analysis
• Contextual Relevance

The answer

The policy mix

In Italy, a contractionary policy mix—characterized by tighter monetary policy and fiscal austerity tends to exacerbate regional disparities, especially between the industrialized North and the less-developed South (Mezzogiorno).

Greater impact on the south

With weaker industrial bases, higher unemployment rates, and greater reliance on public sector jobs and social spending, fiscal austerity directly reduces household incomes and public investment, further dampening economic activity.

How to solve it

To mitigate these effects, regionally targeted policies, such as structural funds or investments in infrastructure, are critical during such periods.

Was the prompt usefull

Using Math AI

How does a fiscal expansion of $100 billion through government spending translate into a specific increase in output (Y) in the IS-LM model, given a marginal propensity to consume (MPC) of 0.8? Please help me to solve it step by step, and explain the formula used.

03

The MPC represents the proportion of additional income spent on consumption.

• Here, MPC = 0.8 means:
• For every extra $1 received, $0.80 is spent on goods/services, and $0.20 is saved.

ΔY=Multiplier×ΔG ΔY=5×100=500billion Result: The increase in output (ΔY) is $500 billion.

3. Calculating the Increase in Output (ΔY):

2. The Multiplier Effect:

The answer

1. Understanding the Marginal Propensity to Consume (MPC):

The multiplier captures the total change in output (ΔY) due to a $1 change in spending (ΔG). Multiplier Formula:

• Multiplier = 1/(1-MPC)

• Multiplier= 1/(1-0.8) = 5

Conclusion: A fiscal expansion of $100 billion, with an MPC of 0.8, leads to an increase in output of $500 billion in the IS-LM framework.

The MPC represents the proportion of additional income spent on consumption.

• Here, MPC = 0.8 means:
• For every extra $1 received, $0.80 is spent on goods/services, and $0.20 is saved.

ΔY=Multiplier×ΔG ΔY=5×100=500billion Result: The increase in output (ΔY) is $500 billion.

3. Calculating the Increase in Output (ΔY):

2. The Multiplier Effect:

answer

1. Understanding the Marginal Propensity to Consume (MPC):

The multiplier captures the total change in output (ΔY) due to a $1 change in spending (ΔG). Multiplier Formula:

• Multiplier = 1/(1-MPC)

• Multiplier= 1/(1-0.8) = 5

04

Using veed AI

Can you write 5 impactful metaphors that can help me learn the implementation and the effects of monetary policies on the IS-LM model? Then create an engaging video for students and beginners in the subject to easily understand.

In an interconnected global economy, how does an expansionary policy mix in one major economy spill over to other countries, particularly through trade and financial channels?

Using chatgpt

05

The answer

Trade channels

• Domestic demand increases, leading to higher imports of goods and services
• Benefits its trading partners by boosting their exports, which can spur economic growth in those countries.
• For example, if the U.S. increases infrastructure spending, it may import more machinery, raw materials, or high-tech goods, benefiting exporters in Europe, Asia, and other regions.
• A weaker currency in the major economy makes its exports more competitive globally but simultaneously strengthens trading partners' currencies, potentially reducing their export competitiveness.

Financial channels

• Lower interest rates in the major economy encourage capital outflows as investors seek higher returns abroad, which can lead to an influx of investment in emerging markets or smaller developed economies
• This capital inflow may reduce borrowing costs in recipient countries, stimulate investment, and boost asset prices. However, the risk of overheating or currency volatility increases if these flows are excessive
• Global commodity prices may also rise due to increased demand in the expanding economy, which can benefit commodity-exporting nations but may strain import-dependent countries through higher input costs

06

Using ELEVENLABS

“Can you provide real-life story of how the components of the IS curve (Investment-Savings curve) function in the real economy ? Turn it into a voiceover with a female voice ”

After the 2008 financial crisis, the U.S. Federal Reserve cut interest rates, making borrowing cheaper, which boosted investment by businesses. The government also increased spending through a stimulus package, raising demand for goods and services. Meanwhile, savings increased as consumers were cautious, but as confidence grew, consumer spending picked up. These actions shifted the IS curve to the right, leading to higher output and economic recovery.

The IS-LM (Investment-Saving, Liquidity Preference-Money Supply) model is a macroeconomic tool used to illustrate the interaction between the goods market (IS curve) and the money market (LM curve) to determine equilibrium levels of interest rates and output. While the IS-LM model has been widely taught and applied, its effectiveness and relevance in representing real-life economic situations and informing government policy is subject to debate. With one paragraph per side of the argument explain the viability of applying the model in real-life problems. Also include a real-world example.

Prompt 7 Efficiency of the IS-LM model

The answer

Basic Framework for Policy Interaction:

The IS-LM model simplifies the interaction between fiscal and monetary policy, showing how changes affect output and interest rates, making it a valuable starting point for understanding macroeconomic policy.

Critiques and Limitations:

The model's assumptions, like fixed price levels and closed economy dynamics, oversimplify real-world complexities, limiting its application in modern scenarios like globalization and liquidity traps.

Historical Application:

It effectively explains short-run economic fluctuations and has historical relevance, such as its role in shaping policy responses during the Great Depression and the New Deal era.

Modern Relevance:

While the IS-LM model is conceptually useful, contemporary challenges demand more advanced tools and empirical models, positioning IS-LM as a foundational but incomplete framework.

Using chatgpt Diagrams

Make a flowchart to help me visualize the relationship between the money demanded and the money supplied in an economy.

08

The answer

The flowchart illustrates the dynamics of the money market equilibrium, where money supply and demand determine the balance. The money supply is controlled by the central bank and is fixed in the short term. Money Supply: Fixed and controlled by the central bank. Money Demand: A function of income (YYY) and interest rates (rrr). Equilibrium Condition: Where M/P=L(Y,r)M/P = L(Y, r)M/P=L(Y,r). Effects: YYY increases: Money demand increases rrr increases: Money demand decreases. Changes in income or interest rates affect money demand: higher income boosts it, while higher interest rates reduce it, maintaining the balance in the market. This interplay is crucial for monetary policy and financial stability.

09

Using ChatGPT

“Can you provide diagrams or charts to illustrate how the IS/LM curves shift with different policy mixes and relate it to real-life examples?”

The answer

Expansionary Fiscal Policy The blue dashed line Real-life example: During a recession, governments might lower taxes or increase infrastructure spending to boost demand

Expansionary Monetary Policy The green dashed line Real-life example: Central banks lowering interest rates to encourage borrowing and investment, as seen in post-2008 financial crisis actions.

BaselinesThe blue solid line (IS) The green solid line (LM)

How does the concept of the liquidity trap challenge the effectiveness of monetary policy, and what alternative strategies can policymakers use to stimulate the economy in such situations? Provide examples, such as Japan's 'Lost Decade' or the 2008 Global Financial Crisis.

Using owlift

10

The answer

*Definition of Liquidity Trap: Occurs when interest rates are at or near zero, rendering monetary policy ineffective in stimulating the economy. * Preference for Cash: People prefer holding cash over bonds or other interest-bearing assets because the opportunity cost of holding cash is negligible. * Ineffectiveness of Traditional Tools: Traditional monetary policy tools, like reducing interest rates, fail to boost investment and consumption in such situations. * Example 1: Japan's Lost Decade (1990s): Interest rates were close to zero, but economic growth stagnated, and deflation persisted. * Example 2: 2008 Global Financial Crisis: U.S. Federal Reserve reduced interest rates to near zero, but recovery was slow as businesses and consumers hesitated to spend or invest.

TRIVIALMACRO

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QUIZ

QUESTION 1

In the IS-LM model, the "sweet spot" is where the IS and LM curves intersect. This point shows the balance between interest rates and output, meaning the economy is in equilibrium with no excess demand or supply.

Explanation

QUESTION 1

QUESTION 2

During the 2008 crisis, the government increased spending to boost demand in the economy. This raised output and shifted the IS curve to the right, meaning more economic activity at any given interest rate.

Explanation

QUESTION 2

QUESTION 3

Monetary policy affects the LM curve by changing the money supply and interest rates, which impacts the money market equilibrium. Lower interest rates, for example, shift the LM curve.

Explanation

QUESTION 3

QUESTION 4

The Marginal Propensity to Consume (MPC) refers to the additional income that a household spends on consumption, rather than saving. It is a measure of how much consumption increases when income rises by one unit.

Explanation

QUESTION 4

QUESTION 5

A contractionary policy mix typically involves reducing government spending, increasing taxes, or tightening monetary policy (such as raising interest rates). The effects of these policies vary across different regions, especially in countries with significant regional disparities.

Explanation

QUESTION 5

QUESTION 6

An expansionary policy mix involves increasing government spending, cutting taxes, lowering interest rates or increasing the money supply to stimulate domestic economic activity. When a major economy (such as the U.S. or the EU) enacts expansionary policies, the effects can spill over to other countries in the global economy, and one of the primary ways this happens is through increased demand for imports.

Explanation

QUESTION 6

QUESTION 7

Equilibrium in the money market occurs when the real money supply equals money demand, balancing liquidity preferences with interest rates.

Explanation

QUESTION 7

QUESTION 8

The IS-LM model illustrates how goods and money markets interact, allowing policymakers to evaluate fiscal and monetary policy effects on output and interest rates, guiding economic decisions in real-world scenarios.

Explanation

QUESTION 8

QUESTION 9

Expansionary fiscal policy boosts output by increasing demand, while expansionary monetary policy lowers interest rates by expanding money supply. Combined, they drive higher economic growth with reduced borrowing costs.

Explanation

QUESTION 9

QUESTION 10

In a liquidity trap, interest rates are near zero, making traditional monetary policy ineffective. Alternatives like fiscal stimulus, quantitative easing, and forward guidance stimulate demand and economic activity without relying on rate cuts.

Explanation

QUESTION 10

Thank You