Overview: Problems of Feedback

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Reading Selections:




The ISLM model has three fundamental assumptions about how people behave: consumption depends on expected income, investment depends on interest rates, and money demand depends on interest rates and expected income. The first, the consumption function, was the basis for the simple income-expenditure model. The other two, that both investment and the demand for money depend on interest rates, result in the addition of financial markets to the model.

In examining all three of these assumptions about behavior, economists have had to struggle with the problem of feedback. Feedback exists when causation runs two ways, when changes in variable A cause changes in variable B, but in turn changes in variable B cause changes in variable A. This group of readings examines some feedback problems with which macroeconomics has had to deal.

After you complete this unit, you should be able to:

  • List the problems of using a monetary aggregate as a measure of monetary policy.
  • List the problems of using interest rates as a measure of monetary policy.
Copyright Robert Schenk