An application: Pension systems and transitions

The classical IS-LM model does not have inflation and inflation expectation in it; it is exogenous. The LM curve shifts as the price level changes and subsequently the real money supply changes assuming the money stock stays the same. The decreasing interest rate pressure on the private sector translates into an accelerating rise in investments. Suppose an economy is at unemployment equilibrium. Inflation is stable so the central bank has no price-caused reason to intervene. To stimulate the economy, the central bank cuts (nominal) interest rate horizon. One type frequently discussed is when expansionary fiscal policy reduces investment spending by the private sector. The government spending is "crowding out" investment because it is demanding more loanable funds and thus causing increased interest rates and therefore reducing investment spending. This basic analysis has been broadened to multiple channels that might leave total output little changed or even smaller. As Keynesian economics, the Phillips curve provided a menu of tradeoffs for policy-makers: They could use demand management policies to increase output and decrease unemployment, but this could only be done at the expense of higher inflation.