Interactive modelAdvanced Macro & Growthintermediate

IS-LM

Goods market meets money market: fiscal and monetary policy in one diagram.

Equilibrium: Y* = 53.3, r* = 4.7

Current equations

IS: r = 9 − 0.08·YLM: r = 1 + 0.07·Y

Two markets, one picture. The IS curve collects all the combinations of interest rates and output where the goods market clears (lower rates → more investment → more output). The LM curve does the same for the money market (more output → more money demand → higher rates). Where they cross, both markets clear at once.

Source: Blanchard, Macroeconomics, ch. 5-6

Shift the curves

Fiscal policy (G up / T down)0

Expansionary fiscal policy raises spending at every interest rate. IS shifts right.

Monetary policy (money supply)0

Monetary easing lowers the interest rate at every output level. LM shifts down/right.

The IS-LM model, in writing

Definition

A two-market model of the short run: the IS curve collects all goods-market equilibria (investment = saving) and the LM curve all money-market equilibria; their crossing pins down output and the interest rate simultaneously.

IS: Y = C(Y-T) + I(r) + G ; LM: M/P = L(r, Y)

The intuition

Fiscal policy shifts IS: more government spending raises output but also interest rates, so some investment is crowded out. Monetary policy shifts LM: more money lowers rates and raises output. The model's power is showing the policy MIX: the same output level can come with high G and high r, or easy money and low r.

Exam tip

Say which curve shifts and why, then read off BOTH the output and interest-rate effects. Fiscal expansion raising r (crowding out) is the detail markers look for.

Related models in Advanced Macro & Growth

Mundell-Fleming (Open-Economy IS-LM) →Fisher Equation →Government Budget Constraint & Seigniorage →Solow-Swan Growth Model →