Extending the IS-LM Model

• New IS relation = Y = C(Y-T)+I(Y, r, x)+G
• New LM relation = r = r bar
• Keep x as low as possible = less problematic for economy
• New relations = more realistic and done at a very aggregate level
• Real policy rate = the rate in the LM relation
• Real borrowing rate = the rate in the IS relation
• Risk premium changes = impacts IS curve, not LM curve
• Issues in financial system induce a recession = decrease in output and financial crisis becomes a macroeconomic crisis
• To maintain balance = x goes up, r goes down
• World with a lot of inflation = CB gets to play around a lot with monetary policy