THE IS CURVE: OUTPUT AND THE REAL INTEREST RATE

IMPORTANCE OF THE INTEREST RATE

• The real interest rate
• May be the most important price in the economy
• Represents the opportunity cost of spending
• Is the price that determines this year’s aggregate expenditure
• Is a lever policymakers use to influence the economy

AGGREGATE EXPENDITURE AND INTEREST RATES

• Lower interest rates boost
• Consumption
• Investment
• Government purchases
• Net exports

SO FAR WE KNOW THAT

THE REAL INTEREST RATE AND AGGREGATE EXPENDITURE

LOWER INTEREST RATES BOOST AGGREGATE EXPENDITURES

AND AN INCREASE IN THE OUTPUT GAP

THE IS CURVE

THE IS CURVE - STEP 1

THE IS CURVE - STEP 2

THE IS CURVE - STEP 3

CHANGING INTEREST RATES LEADS TO A MOVEMENT ALONG THE IS CURVE - STEP 1

CHANGING INTEREST RATES LEADS TO A MOVEMENT ALONG THE IS CURVE - STEP 2

CHANGING INTEREST RATES LEADS TO A MOVEMENT ALONG THE IS CURVE - STEP 3

IF THE INTEREST RATE FALLS FROM 5% TO 3%,

• The IS curve shifts to the right
• The IS curve shifts to the left
• We move to the right along the IS curve
• We move to the left along the IS curve

REVIEW: IS CURVE

• Lower interest rates increase aggregate expenditure
• In response, businesses increase output, which leads to an increase in GDP
• An increase in GDP results in an increase in the output gap
• The IS curve illustrates how lower real interest rates lead to a more positive output gap