Silviase/jgov_v1.4_full_ann huggingface dataset:
II. The IS·LM Curves and the Impact of Fiscal Policy

### 1. The Textbook IS·LM Curves and their Determinants

(1) The Slope of the IS Curve and its Determinants

The IS curve differs depending upon which variables are endogenized and which are exogenized (i.e., depending upon the scope of the endogenized variables). The IS curve that is closest to the textbook IS curve is thought to be that which endogenizes only the final expenditure block except capital stock. Table II·1 shows the IS curve derived this way and summarizes the underlying income and interest elasticities of the aggregate demand for the third year. As seen, the West German IS curve is very flat and the U.S., Italian, and Japanese curves are also rather flat; while the curves for the other countries are steep, with particularly steep curves described for Australia and the Republic of Korea. These differences are generally explained by the differences in the interest elasticity of the aggregate demand (especially investment), and the income elasticity is thought to have little effect. Thus the greater the interest elasticity, the flatter the IS curve is likely to be; and the smaller the interest elasticity, the steeper the IS curve.

Let us see what happens to the slope of the IS curve when the scope of endogenous variables is broadened while the final expenditure block is still endogenous. Table II·2 indicates the results in the three successively broader cases of (i) also endogenizing capital stock in the final expenditure block, (ii) additionally endogenizing the income distribution and government blocks, and (iii) additionally endogenizing the balance of payments and financial blocks.

Endogenizing capital stock leads to smaller GNP expansion under lower interest rates because of the effect of stock adjustment (namely that the larger stock tends to depress investment) and hence the IS curve becomes steep compared with the case where capital stock is not endogenized.

It is generally expected that endogenizing the income distribution and government blocks leads to larger GNP expansion under lower interest rates because of possible increases in disposable income and that the IS curve therefore becomes flatter. However, the decline in interest income resulting from lower interest rates has the reverse effect on disposable income and leads to a steeper IS curve in countries where interest income is endogenized. The United States and Japan are the only countries for which interest income is endogenized in the EPA model. Both countries clearly demonstrate this effect and show marginally steeper IS curves. The curve becomes flatter in the other six countries for which interest income is not endogenized.
Table II·1 Slope of the Pure IS Curve and Income & Interest Rate Elasticities of the Aggregate Demand (3rd year)

Slope of the pure $ IS^{1)} $	Income elasticity	Interest rate semi-elasticity
West Germany	$ \Delta $ 0.54	0.35	$ \Delta $ 1.24
U. S.	$ \Delta $ 1.13	0.97	$ \Delta $ 0.49
Italy	$ \Delta $ 1.68	0.83	$ \Delta $ 0.27
Japan	$ \Delta $ 1.72	0.76	$ \Delta $ 0.46
France	$ \Delta $ 2.58	0.39	$ \Delta $ 0.25
U. K.	$ \Delta $ 3.15	0.55	$ \Delta $ 0.19
Australia	$ \Delta $ 4.50	1.03	$ \Delta $ 0.073
Korea	$ \Delta $ 5.79	0.73	$ \Delta $ 0.068

(Notes) 1. The slope of the IS is measured by deviation from baseline in interest rate divided by percentage deviation from baseline in GNP.

2. In Canada, the slope of the IS is not calculated with technical reason

3. $ \Delta $ indicates minus (this is the same in subsequent tables)
Table II·2 Changes in the Slope of the IS Curve by the Different Scope of the Endogenized Variables (3rd year)

Block and variables endogenized cumulatively
Final (1) expenditure block (exc.capital stock variables)	(2) Capital stock variables	(3) Distribution and government block	(4) Financial and the balance of payments block
West Germany	Δ 0.54	Δ 0.67	Δ 0.33	Δ 0.66
U. S.	Δ 1.13	Δ 1.42	Δ 1.46	Δ 1.21
Italy	Δ 1.68	Δ 1.92	Δ 0.79	Δ 1.49
Japan	Δ 1.72	Δ 1.90	Δ 2.01	Δ 2.12
France	Δ 2.58	Δ 2.61	Δ 1.05	Δ 1.62
U. K.	Δ 3.15	Δ 3.44	Δ 1.72	Δ 13.45
Australia	Δ 4.50	Δ 9.04	Δ 2.23	Δ 13.87
Korea	Δ 5.79	Δ 9.46	Δ 2.36	Δ 12.77

(Notes) 1. See notes of Table II·1.

2. Figures in column (1) are the same as the slope of the pure IS in Table II·1.
It is also expected that endogenizing the balance of payments block should lead to an increase in imports and hence a decrease in GNP, thereby yielding a steeper IS curve. However, endogenization of the balance of payments block results in a flatter IS curve for the United States. This is attributed to the fact that GNP actually expands as the effect of a decline in interest payments accruing from lower interest rates outweighs the impact of greater imports.

As seen, the slope of the IS curve changes considerably depending upon the scope of variables that are endogenized in the model. However, there is little change in the eight countries' relative positions whether one uses the textbook-type pure IS curve or the IS curve derived with the broadest endogenization.

The fiscal multiplier changes as time passes on after fiscal shock is given. In order to understand the temporal changes in the fiscal multiplier, it is important to look at the temporal changes in the slope of the IS curve. Looking first at the pure IS curve, this gets flatter for the first few years and then becomes steeper for the remaining years - a result of the fact that income and interest rates have such a lagged impact on consumption and private investment, that the income and interest elasticities of aggregate demand become greater over time for the first few years, and that these elasticities then peak out and decline in subsequent years as shown in Table II·3 $ ^{[1]} $ . The same time profile of changing slopes is observed in the IS curve derived with the broadest endogenization. But the scale of changes in the slope is larger as the capital stock adjustment effect gets stronger over the years.

## (2) The Slope of the LM Curve and its Determinants

Unlike the IS curve, the financial block is highly independent from the other blocks. The result is that the slope of the LM curve changes very little even when the scope of endogenous variables is varied. Table II·4 gives the slope of the LM curve for the third year derived from the full model (except supply block) simulations. The income and interest elasticities of money demand remain the main determinants of the slope of the LM curve.

In Canada’s case, the LM curve is completely elastic because the short-term interest rate function (the inverted form of the money demand function) does not include the income variable as an explanatory variable. For the other countries, the curves are very flat for West Germany and rather flat for the United Kingdom and France. By contrast, the curves for the remaining five countries are steep, being particular steep for the Republic of Korea. These differences can be largely explained by the differences in the interest elasticity of money demand, the LM curve being steeper the smaller the interest elasticity.
Table II - 3 Slope of the Pure IS Curve and Income & Interest Rate Elasticities of the Aggregate Demand (Temporal Change)

Slope of the pure IS $ ^{1)} $	Interest rate semi-elasticity of Aggregate Demand	Income elasticity of Aggregate Demand
1st year	the flattest year	6th year	1st year	6th year	1st year	6th year
West Germany	$ \Delta $ 0.67	$ (2)^{2} $	$ \Delta $ 0.56	$ \Delta $ 0.75	$ (2)^{2} $	$ \Delta $ 1.17	$ \Delta $ 1.26	0.26	$ (2)^{2} $ 0.40
U. S.	$ \Delta $ 1.21	$ (4) $	$ \Delta $ 1.14	$ \Delta $ 0.38	$ (4) $	$ \Delta $ 0.52	$ \Delta $ 0.50	0.75	$ (4) $ 1.00
Italy	$ \Delta $ 4.58	$ (5) $	$ \Delta $ 1.52	$ \Delta $ 0.12	$ (5) $	$ \Delta $ 0.32	$ \Delta $ 0.32	0.37	$ (5) $ 0.98
Japan	$ \Delta $ 4.21	$ (3) $	$ \Delta $ 1.84	$ \Delta $ 0.24	$ (3) $	$ \Delta $ 0.46	$ \Delta $ 0.46	0.49	$ (3) $ 0.76
France	$ \Delta $ 52.85	$ (5) $	$ \Delta $ 3.24	$ \Delta $ 0.06	$ (5) $	$ \Delta $ 0.26	$ \Delta $ 0.26	0.26	$ (5) $ 0.42
U. K.	$ \Delta $ 3.57	$ (3) $	$ \Delta $ 3.63	$ \Delta $ 0.19	$ (3) $	$ \Delta $ 0.18	$ \Delta $ 0.17	0.17	$ (3) $ 0.55
Australia	$ \Delta $ 12.12	$ (5) $	$ \Delta $ 4.91	$ \Delta $ 0.06	$ (5) $	$ \Delta $ 0.07	$ \Delta $ 0.07	0.66	$ (5) $ 1.08
Korea	$ \Delta $ 9.58	$ (4) $	$ \Delta $ 6.90	$ \Delta $ 0.06	$ (4) $	$ \Delta $ 0.06	$ \Delta $ 0.05	0.27	$ (4) $ 0.76

(Notes) 1. See notes of Table II - 1.

2. Figures in parentheses indicate the year in which the slope of the pure IS is flattest.
Table II - 4 Slope of the Pure LM Curve and Income & Interest Rate Elasticities of Money Demand (3rd year)

Slope of the pure LM curve $ ^{1)} $	Income elasticity	Interest rate semi-elasticity
Canada	0.0	0.0	$ \Delta $ 119.32
West Germany	0.09	0.87	$ \Delta $ 11.41
U. K.	0.20	1.70	$ \Delta $ 6.09
France	0.21	21.73	$ \Delta $ 69.45
Italy	0.38	1.06	$ \Delta $ 2.67
Japan	0.43	0.68	$ \Delta $ 2.45
Australia	0.55	1.10	$ \Delta $ 1.67
U. S.	0.59	1.07	$ \Delta $ 3.71
Korea	1.38	1.17	$ \Delta $ 1.11

(Note) 1. The slope of the LM is measured by deviation from baseline in interest rate divided by percentage deviation from baseline in GNP.
The temporal changes in the slope of the LM curve are also important for understanding the temporal changes in the fiscal multiplier. Excluding Canada, where the slope is consistently zero, three types may be observed: (i) the United States, France, Australia, and Italy, which become almost consistently steeper over time, (ii) Japan, the United Kingdom, and the Republic of Korea, which start out steep but turn flat after the second year, and (iii) West Germany, which becomes almost consistently flatter over time. As such, the LM curve stands in sharp contrast to the IS curve, which starts out flat and then turns steeper in all countries. This difference in the LM curves' temporal progressions can largely be explained by the differences in temporal changes for the interest elasticity of money demand - to wit: (i) interest elasticity becoming progressively smaller for group one countries, (ii) interest elasticity being small at first yet growing larger over time for group two countries, and (iii) interest elasticity becoming consistently large for West Germany - as shown in Table II·5 $ ^{[2]} $ .

### 2. The Impact of Fiscal Policy and IS·LM Curves

## (1) Analytical Framework

This section attempts to explain the differences in the effects of fiscal policy among countries drawing upon the differences in the slopes and shifts of the IS and LM curves. The framework is represented by Figure II·1. (The basic approach underlying this framework is based on B. Friedman [3] and B. Hickman [4].)

$ IS_{0} $ and $ LM_{0} $ in Figure II·I represent the IS and LM curves prior to fiscal shock. With fiscal shock, the IS curve shifts from $ IS_{0} $ to $ IS_{1} $ (hereinafter referred to as the initial shift). If the LM curve is absolutely flat, the point of equilibrium moves from A to C. However, so long as the IS and LM curves have slopes, the point of equilibrium shifts to D through both an increase in interest rates and a decline in GNP. The decline in GNP from C to D is referred to as transaction crowding out.

While this analysis holds if prices and wealth remain unchanged, the increase in government expenditures is accompanied by an increase in wealth and a rise in prices. In Figure II·1, the result of this increase in wealth shows up in the IS curve's assumed expansionary shift from $ IS_{1} $ to $ IS_{2} $ due to a wealth-induced consumption increase and the LM curve's contractionary shift from $ LM_{0} $ to $ LM_{1} $ due to a wealth-induced money demand increase. The resultant decline in GNP from D to E is referred to as portfolio crowding out. (It should be noted, however, that portfolio crowding in may occur when the IS curve's expansionary shift outweighs the LM curve's contractionary shift as it does in Figure II·1.)
Table II·5 Slope of the Pure LM Curve and Income & Interest Rate Elasticities of Money Demand (Temporal Change)

Slope of the pure LM $ ^{1)} $	Interest rate semi-elasticity of money demand	Income elasticity of money demand
1st(1) year	6th(2) year	(2) (1)	(3) 1st year	6th (4) year	(4) (3)	1st(5) year	6th(6) year	(6) (5)
Canada	0.0	0.0	0.0	$ \Delta $ 55.31	$ \Delta $ 183.25	3.31	0.0	0.0	0.0
West Germany	0.11	0.08	0.73	$ \Delta $ 7.91	$ \Delta $ 13.30	1.68	0.62	0.89	1.44
U. K.	0.18	0.15	0.83	$ \Delta $ 5.94	$ \Delta $ 8.82	1.48	1.70	1.70	1.0
France	0.12	0.20	1.67	$ \Delta $ 98.89	$ \Delta $ 94.02	0.95	21.73	21.73	1.0
Italy	0.32	0.39	1.22	$ \Delta $ 3.14	$ \Delta $ 2.67	0.85	1.06	1.06	1.0
Japan	0.41	0.34	0.83	$ \Delta $ 2.72	$ \Delta $ 2.84	1.04	0.71	0.62	0.87
Australia	0.38	0.52	1.37	$ \Delta $ 3.22	$ \Delta $ 2.10	0.65	1.10	1.10	1.0
U. S.	0.26	0.66	2.54	$ \Delta $ 7.14	$ \Delta $ 2.90	0.41	1.07	1.00	0.93
Korea	0.80	0.90	1.13	$ \Delta $ 0.91	$ \Delta $ 1.55	1.70	0.74	1.17	1.58

(Note) 1. See note of Table II·4.
Figure II·1 Framework of the IS·LM under Fiscal Impact

(Notes) 1. GNP is measured by percentage change and interest rate is measured by difference.

2. Subscript 0 means standard case, and the others show cases after fiscal impact.

3. For details, see II·2·(1) in the paper.
Likewise, the impact of the rise in prices shows up in the IS curve's contractionary shift from $ IS_{2} $ to $ IS_{3} $ and the LM curve's contractionary shift from $ LM_{1} $ to $ LM_{2} $ . The shift from E to B · the decline in GNP as prices rise along the line with the aggregate supply curve · is referred to as inflation crowding out.

## (2) The Size of the Initial Shift of the IS Curve and its Determinants

The fiscal policy examined here is a sustained increase in real government expenditures equivalent to 1% of real GNP. The horizontal axis in Figure II·1 represents the percentage deviation from the base line real GNP. As seen in Table II·6, the size of the initial shifts of the IS curve under the fiscal shock differs considerably from country to country $ [3] $ . The following simple multiplier calculations demonstrate that there will be differences in the sizes of initial shifts caused by differences in marginal propensities to consume, import, etc.

Designating the marginal propensity to consume c, the marginal propensity to invest i, and the marginal propensity to import m, when government expenditures increase by $ \Delta G $ , the increase in GNP will be $ \Delta G/(1 - c - i + m) $ . This simplified fiscal multiplier are shown in Table II - 6, which can be compared with the size of the initial shift of the IS curve under fiscal shock simulations. This comparison indicates that the scale of the initial shift of the IS curve is generally close to the value for the simplified fiscal multiplier. In the simplified calculations of fiscal multiplier, the marginal propensities to consume, invest and import are assumed to remain constant over time. In contrast, however, macro - model simulations capture changing propensities over time. For instance, the lagged impact of income on consumption and private investment gets increasingly larger over time, whereas the capital stock adjustment and a lagged effect of income on imports tend to reduce the fiscal multiplier.

Looking at the temporal progression in the initial shift, the size of the shift gradually diminishes over the six years in the United States and Canada, while it grows annually in the United Kingdom. And there is an initial decline in the initial shift followed by increase for West Germany. In the other five countries, grows larger at first (the first three to five years) and then shrinks.

An important point that we can derive from examining the determinants of the scale of the initial shift of the IS curve under fiscal shock is that the time profile of the fiscal multiplier is influenced not only by induced changes in interest rates, net wealth, and prices but also by the temporal progression of the initial shift of the IS curve, i.e. the temporal progression of the fiscal multiplier in the
Table II·6 Comparison between the Initial Shift in the IS and the Simplified Fiscal Multiplier

Initial Shift $ ^{1)} $	Simplified Fiscal Multipier $ ^{1)} $
1st year	peak (bottom)	6th year	1st year	peak (bottom)	6th year
U. S.	1.87	monotonic decline	1.61 ( $ \Delta $ 0.26) $ ^{3)} $	1.73	(2) $ ^{2)} $	1.67 ( $ \Delta $ 0.06) $ ^{3)} $
Canada	1.58	monotonic decline	1.24 ( $ \Delta $ 0.34)	1.38	monotonic decline	1.19 ( $ \Delta $ 0.19)
France	1.41	(5) $ ^{2)} $	1.59 (0.18)	1.26	(3)	1.40 (0.14)
Italy	1.41	(5)	2.72 (1.31)	1.28	(5)	1.67 (0.39)
West Germany	1.31	(4)	0.63 ( $ \Delta $ 0.68)	1.27	(2)	1.23 ( $ \Delta $ 0.04)
Australia	1.26	(3)	1.19 ( $ \Delta $ 0.07)	1.63	(2)	1.64 (0.01)
Korea	1.24	(3)	1.69 (0.45)	1.26	(2)	1.55 (0.29)
Japan	1.09	(5)	1.46 (0.37)	1.46	(2)	1.64 (0.18)
U. K.	1.05	monotonic increase	1.57 (0.52)	1.16	monotonic increase	1.64 (0.48)

(Notes) 1. Both the initial shift and the simplified fiscal multiplier are measured by percentage deviation from baseline in GNP.

2. Figures in parentheses indicate peak (or bottom) year

3. Figures in parentheses indicate differences between 6th year and 1st year.
simple Keynesian framework where there are no induced changes in interest rates, net wealth, and prices. It is thus worth noting that the country differences in the time profile of the fiscal multiplier reflect the differences in this simple Keynesian fiscal multiplier as well as crowding out.

## (3) The Slopes of the IS and LM Curves and Transaction Crowding Out

Table II·7 shows the slopes of the IS and LM curves and the extent of transaction crowding out in the third year based upon the EPA model simulations. In general, transaction crowding out is larger the flatter the IS curve and the steeper the LM curve. As seen, however, it is impossible to attribute country differences in the scale of transaction crowding out either to country differences in the slope of the IS curve or to those of the LM curve. But the size of transaction crowding out corresponds with the relative slope of the IS curve to the LM curve. The transaction crowding out is most prominent in the United States, where the slope of the IS curve is quite flat relative to that of the LM curve and 27% of the initial shift is crowded out. There is also greater·than·10% crowding out in Italy, West Germany (due to a quite flat IS curve), Japan (both the slopes of the IS and LM curve are medium), and the Republic of Korea (quite steep LM curve), but crowding out is less prominent in the other four countries. In Canada, the fact that the LM curve is completely flat, for the reasons which have already been explained, means that there is no crowding out at all.

The temporal progression for transaction crowding out demonstrates a pattern of increasing at first (in the first two to five years) and then diminishing (see Table II·8). These temporal changes in transaction crowding out correspond to the temporal progressions shown by the slope of the IS and LM curves. Canada and Italy are exceptions for this general time profile for the transaction crowding out. In Canada there is none and in Italy the crowding out becomes consistently large.

## (4) Wealth · change · induced Shifts in the IS and LM Curves and Portfolio Crowding Out

When an increase in government expenditures is financed by issuing government bonds and also accompanied by an increase in real assets due to increased private investment, there is also an increase in wealth (financial net worth defined as the sum of the cumulative government deficit and the cumulative current account surplus and total net worth defined as the sum of financial net worth and capital stock) $ ^{[4]} $ . As a result of the wealth increase, the IS curve shifts rightward and the LM curve leftward. While the leftward shift in the
Table II·7 Relation between the Size of Transaction Crowding-out and the Slope of the IS·LM (3rd year)

(1) Initial1) Shift	(2) Transaction1) Crowding-out	Rate of loss By Transaction Crowding-out ((2) / (1))	(3) Slope2) of the IS	(4) Slope2) of the LM	(3) (4)

U. S.	1.75	0.47	0.27	Δ 1.63	0.59	2.76
Italy	2.46	0.41	0.17	Δ 1.92	0.38	5.05
West Germany	0.79	0.12	0.15	Δ 0.50	0.09	5.56
Japan	1.48	0.21	0.14	Δ 2.55	0.43	5.93
Korea	1.97	0.20	0.10	Δ 13.55	1.38	9.82
France	1.60	0.11	0.07	Δ 2.94	0.21	14.00
Australia	1.49	0.06	0.04	Δ 14.08	0.55	25.60
U. K.	1.32	0.02	0.01	Δ 14.13	0.20	70.65
Canada	1.38	0.00	0.00	-	0.0	-

(Notes) 1. Both the initial shift and transaction crowding-out are measured by percentage change in GNP.

2. The slope of the IS and LM is measured by deviation from baseline in interest rate divided by percentage deviation from baseline in GNP.

3. In Canada, the slope of the IS is not calculated with technical reason.
Table II·8 Relation between the Size of Transaction Crowding-out and the Slope of the IS·LM (Temporal Change)

Rate of Loss by Transaction Crowding-out	Slope of the pure IS²)	Slope of the pure LM
1st year	Peak	6th year	1st year	6th year	1st year	6th year
U.S.	0.18	(2)³	0.25	Δ 1.15	(2)³	Δ 1.46	Δ 1.99	0.26	(2)³
Italy	0.05	monotonic increase	0.25	Δ 5.66	monotoni-ously flat	Δ 1.21	0.32	monotonio-usly steep	0.39
West Germany	0.17	(2)	0.06	Δ 0.54	(2)	Δ 0.38	Δ 1.34	0.11	(2)
Japan	0.07	(3)	0.08	Δ 5.73	(3)	Δ 2.55	Δ 4.14	0.41	(3)
Korea	0.04	(3)	0.03	Δ 1.33	(3)	Δ 13.55	Δ 32.98	0.80	(3)
France	0.01	(5)	0.07	Δ 17.14	(5)	Δ 2.11	Δ 5.53	0.12	(5)
Australia	0.02	(2)	0.01	Δ 18.28	(2)	Δ 12.58	Δ 61.60	0.38	(2)
U.K	0.01	(2)	0.01	Δ 11.75	(2)	Δ 13.83	Δ 15.09	0.18	(2)
Canada	0.0	0.0	-	-	-	0.0	0.0

(Notes) 1. Rate of loss by transaction crowding-out is measured by transaction crowding-out divided by the initial shift.

2. The slope of the IS·LM is measured by deviation from baseline in interest rate divided by percentage deviation from baseline in GNP.

3. Figures in parentheses indicate the year in which transaction crowding out is largest.

4. In Canada the slope of the IS is not calculated with the technical reason.