UsingtheIS-LMModelforReading.pptVIP

Using the IS-LM Model for Reading the Wall Street Journal An odd thing happened the last time Alan Greenspan testified before congress...Longest-term interest rate: 30-year bond rate up from 6.03% to 6.47% in the four market days surrounding the testimony, from Friday to Wedneday. Think about that: 6.47% - 6.03% = 0.44%, times 30 years = 13.2%. Everything in 2025 was just marked down in price by some 13%. A huge shift in relative values.Why did this happen? Not completely sure: supply and demand in the bond market. But people doing the selling (and people watching the bond market) said that they saw two reason:First, Greenspan more-or-less dismissed the chance of a recession in the near future...Second,Greenspans Humphrey-Hawkins testimony provided an occasion for people to reevaluate their views on future government policy, and what they saw was a much lower chance of a deficit reduction deal, of the spending cuts and tax increases that would bring the deficit back into balance.Why should these changed expectations of future policy change interest rates now?Begin with what policy will be in the future. A lower deficit means either that G is down, or T is up (and thus that consumption is down). A chance of recession means a chance that investment demand will fall--hence that I will fall. All of these pull the IS curve in and to the left. Thus before Alan Greenspans testimony, people were expecting a good chance that at some time in the relatively near future the IS curve would shift sharply in and to the left. But people werent expecting it to end there. The Federal Reserve is not a houseplant--and while they may dislike inflation more than most of the rest of us do, they also dislike unemployment. Expectations were that there was a good chance that (a) this inward shift of the IS curve would, when it happened, be offset by a sharp reduction in interest rates, as the Federal Reserve sought to push the economy down the IS curve and so offset the incipient