A monetary policy rule (MPR)
specifies how the central bank
adjusts interest rates in
response to changes in
particular economic variables.
Following a monetary target,
the central banks adjusts
interest rates to maintain the
quantity of money demanded in
line with the given target for
money supply.
The IS schedule shows
combinations of income and
interest rates at which
aggregate demand equals
actual output.
The LM schedule shows
combinations of interest rates
and income yielding money
market equilibrium when the
central bank pursues a given
target for the nominal money
supply.
A fiscal stimulus to aggregate
demand crowds out some
private spending. Higher output
induces a rise in interest rates
that dampen the expansionary
effect on demand by reducing
some components of private
spending.
Demand management uses
monetary and fiscal policy to
stabilize output near potential
output.
Government solvency requires
that the present value of the
current and future tax revenue
equals the present value of
current and future spending
plus any initial net debts.
Ricardian equivalence says
that it does not matter when a
government finances a given
spending programme. Tax cuts
today do not affect private
spending if, in present value
terms, future taxes rise to
match.
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