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Current time:0:00Total duration:7:49

Video transcript

we've already studied the is curve in some detail and just as a bit of a review here it's just relating real interest rates to real GDP real let me just write that as Y real GDP and the relationship there's what two ways we've viewed it one is real interest rates driving investment which drives real GDP or to say real interest rates driving planned investments which drives which drives Gd real GDP and if you have a high real interest rate then you're not going to have as much planned investment and if you looked at our Keynesian cross you it's pretty clear that if you don't have as high planned investment you will you will not have as high of a GDP and so or high of a real GDP and similarly if you have a low real interest rate you will have more planned investment and you will have a higher real GDP and so our is curve looks like this our is curve is downward-sloping and I'll do it easier for me to draw a dotted line so that right over there is our is curve stands for investment savings curve this right here is taking it much more from the investment side how real interest rates drive investment you could also view it from the other angle you could view how how real GDP drives savings which drives interest rates and that interpretation at low levels of GDP you have less savings that's essentially there is less excess capital to go around and so it is scarce the price of that is expensive and the price of money is real is interest rates and if we're dealing in real terms real interest rates and so it would be high and if you have higher GDP and everything else is held constant if government spending is held constant consumer spending will go up but it won't go up as high as GDP you're going to have more savings there's more stuff to lend around and so the price of that's asked for lending that money will go down and that price is real interest rates so these are two ways of viewing it this is kind of the savings driven way and this is the real interest rates driving investment and so that's why it's called the is curve investment say investment savings curve now what I want to talk about is the LM curve LM so let me draw a little line over here although I'm going to plot it on top of this so that we can start thinking about the equilibrium level of interest real interest rate in real GDP so the LM curve L M stands for liquidity preference money supply liquidity liquidity preference for reference money supply money supply money supply and liquidity preference it sounds kind of like a fancy thing but it's actually a very basic it's a very basic idea and this is if we hold real money constant and when I talk about real money actually let me clarify here if I talk about real money we're talking about the amount of money in supply if we adjust for something like inflation so you could measure real money in the u.s. you could measure it as base money or maybe the total amount of Federal Reserve notes or m0 you could measure it as M 0 divided by the CPI and so maybe m0 goes up but if the CPI goes up by the same amount by the same percentage then you're not going to have a change in real money if m0 goes up without prices increasing then then real money has gone up if m0 stays constant but prices have increased then real money has gone down but all this look all liquidity preferences describing is if we assume this is constant so at any given level here so assume assume constant then the more economic activity that there is the more demand that there is for that money and so there will be higher real interest rates people are going or will be willing to pay higher prices for that money in real terms so all it's saying is if you have very let's the start over here if you have a lot of economic activity people will want to hold currency so that they can have transactions so they have some flexibility they the money itself is going to be circulating much much more so there's going to be higher demand for that money if there's higher demand for that money people will either be willing to pay more for access to that money or you really have to pay them more for them to give you their money because they really want that liquidity they really want that access to their money and the price of money is interest rates so according to accorded for the LM curve when we think about liquidity preference holding real money constant high levels of GDP a lot of economic activity people want to have currency demand for currencies high so the price of cards use high which is real interest rates and so we would have real interest rates high due to this due to liquidity preference and then on the other side of that if you have low economic activity people might say well there's there's not as much demand for currency too there's fewer transactions going on and so you will have to pay someone less to part with their money or someone's willing to pay less in order to get access to money and so at low levels of GDP according to liquidity preference you're going to have lower real interest rates and so our LM curve our LM curve looks something like this this is is in this dotted line yellow and our LM our LM curve looks something like that and when you plot these two constraints against each other the is is telling us a relationship between real interest rates driving investment and how that affects GDP or how real GDP affects savings affecting real interest rates it's a different constraint then what liquidity preference is telling us this is just how much people as things get better and better more and more acadec anomic activity people want to hold more money so these two different constraints and you take them both into consideration you end up with an equilibrium point there is going to be one point that meets both constraints and this is the point at which the economy is at equilibrium relative to real interest rates and real GDP real interest rates and real GDP now let's think about what would happen if the Federal Reserve decided to print we're if we take a US focus if the central bank or the central federal reserve decides to print more money so print print money and by this definition up here of our of our real money in the very short term especially when we kind of put our Keynesian hat on we assume in the very short term prices are sticky so they in the very short-term this doesn't change much if this goes up then real money goes up especially in the short term real money goes up so if real money goes up you're essentially increasing the supply of real money anytime you increase the supply of real money at any given at any given level of demand people are going to want to pay less for it and so what you're going to have happening is so at any given level of GDP there's now more money there so the price of that money is going to be less the price is a real interest rate so if the Federal Reserve of the central bank prints money and real money increases we're assuming in the very short term that prices don't change because they're sticky so real money has gone up the price of that real money will go down at any given level of GDP and so that would shift that would shift the LM curve down and so we can start to see what would that do to our equilibrium low interest rates and level of GDP well in that situation interest real interest rates the equilibrium real interest rates clearly went down and we also see based on this model some expansion of GDP