Investment Savings and Liquidity Money

Note: If you've come here because your macroeconomics exam is tomorrow, good luck.


The IS curve is a set of points, derived in the Goods Market (see also Keynesian Cross) which are the result of a changing interest rate, holding government spending and net exports constant. A less elastic IS means that monetary policy is less effective. In the extreme case of perfect inelasticity only Fiscal Policy could cause a temporary change in output.

IS elasticity

IS curve comparative elasticity


The LM curve is a set of points from the Money Market for a given demand for money (liquidity preferences) and a supply of money. The two determining factors are the interest rate on bonds and the quantity of money. The points reflect given income and interest rates on horizontal and vertical axix respectively. The key to the elasticity of LM is the interest elasticity of money. The more responsive money demand is to the interest rate, the more elastic is the LM curve. The LM curve holds constant price-level, expectations, and Money Supply.

Classical LM[]

Perfectly vertical corresponding to an area of the money demand function where the change in interest rate does not change the demand for money (the upper vertical part of the money demand). With an LM structure like this, changes in the real money supply are effective, but the extent to which this is anticipated limits the effect. With this assumption Fiscal policy will only succeed in changing the interest rate and will have zero effect on output.

Monetary Policy and Fiscal Policy