Module 06 · Chapters 5

IS-LM Policy Mix

Fiscal vs monetary, expansion vs contraction, the right mix.

“How macroeconomists argue about budgets and rates — geometrically.”

~35 min· 4 sub-skills·6 exercisesExam frequency · high0% mastered

With IS-LM in hand, every macro policy debate reduces to: which curve do you shift, and where does the new equilibrium land? This module catalogues the four canonical interventions plus the mix policymakers reach for.
Definition·Fiscal expansion (↑G or ↓T)
IS shifts right by ΔG/(1−c₁) (or by c₁/(1−c₁)·|ΔT|). Under flat LM: Y rises by the full IS shift; i unchanged. Under upward-sloping LM: Y rises less; i rises (partial crowding out).
Definition·Monetary easing (↓iᵀ)
Movement down along IS: Y rises by b·|Δi| (where b = d₁/(1−c₁)). LM is just relabeled at the new rate. No IS shift.
Figure · Fiscal expansion in IS-LM
Loading IS-LM lab…
Right-shift of IS at fixed iᵀ. Y rises by the full multiplier × ΔG.
Figure · Monetary easing in IS-LM
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Lower iᵀ → movement down IS. Y rises through the investment channel.
Tip·The policy mix
When the goal is to raise Y without changing the composition (more I vs more G), policymakers combine instruments. Tight fiscal + loose monetary raises private investment at the expense of public spending. Loose fiscal + tight monetary does the opposite. Both can hit the same Y target — the difference is structural.
Common misconception
Cutting G and T by the same amount is neutral.
Actually**False — balanced budget multiplier = 1.** Cutting both by 100 reduces Y by 100. The G channel is one-for-one; the T channel is c₁ < 1; net is −(1 − c₁)/(1 − c₁) · 100 = −100... wait, more carefully: ΔY_G = −100/(1−c₁); ΔY_T = c₁·100/(1−c₁); sum = −100·(1−c₁)/(1−c₁) = −100.
Watch out·Zero lower bound (ZLB)
If the CB has cut iᵀ to ~0 and demand is still too low, monetary policy is exhausted. Fiscal expansion becomes the only conventional option — and the ZLB is exactly when fiscal multipliers are largest (no crowding-out by construction). This is the policy logic behind 2008-2010 and 2020 stimulus.
Exercise · numerical · +12 XP
Tax cut multiplier
c₁ = 0.6. ΔT = −50 (tax cut). What is ΔY?
Your answer
Exercise · true false · +8 XP
Crowding out exists?
Crowding out occurs when LM is flat.
"Crowding out occurs when LM is flat."
Exercise · numerical · +12 XP
Δi from −2pp
b = 1500 (slope coefficient on i). The CB cuts iᵀ from 5% to 3%. ΔY?
Your answer
Exercise · multiple choice · +10 XP
Pick the mix
Goal: maintain Y at potential, but **raise** the share of investment (boost capital formation). Pick the policy mix.
Exercise · multi step · +18 XP
Multi-step — Reagan mix
ΔG = +200, ΔiᵀT = +0.04. c₁=0.6, d₁=500.
Context: Loose fiscal + tight monetary (the 1981-83 US 'Reagan-Volcker' mix). Compute the components.
(a)ΔY from ΔG (multiplier × shock):
(b)ΔY from Δi (b × −Δi):
(c)Net ΔY:
Exercise · multiple choice · +10 XP
ZLB and fiscal policy
At the zero lower bound, fiscal multipliers tend to be:

Mastery check

5 questions · pass with 80%

Answer all five to confirm you've internalised the module. A passing run unlocks the next module.

Q1
T rises by 100 (tax hike).
ΔT = +100, c₁ = 0.6, all else fixed.
Q2
"An interest-rate change causes a movement along IS, not a shift."
Q3
Tight fiscal + loose monetary tends to:
Q4
"At the ZLB, conventional monetary policy can no longer expand demand."
Q5
ΔG = ΔT = +60, c₁ = 0.5. ΔY = ?

0 / 5 answered

Exam pitfalls

Confusing fiscal expansion with movement along IS — fiscal *shifts* IS.
Reading 'crowding-out' under flat-LM — there is none; reread the slope of LM in the question.
Assuming the spending multiplier and the tax multiplier are equal in magnitude. Tax multiplier is smaller (factor c₁).
Forgetting that at the ZLB, the standard 'CB will offset fiscal' logic breaks.