Multiplier Effect: Initial shift amplified by consumption response.

Crowding Out: Rise in $r$ due to increased $Y$ (higher money demand) reduces investment, partially offsetting fiscal stimulus.

Monetary Policy (e.g., $\Delta M$): Shifts LM curve.

Increases $M \implies$ lowers $r \implies$ stimulates $I \implies$ increases $Y$.

Relative Effectiveness:

Steeper IS (less interest-sensitive investment) or flatter LM (more interest-sensitive money demand): Fiscal policy more effective.
Flatter IS or steeper LM: Monetary policy more effective.
Liquidity Trap (flat LM): Monetary policy ineffective.
Classical Case (vertical LM): Fiscal policy completely crowded out.

Under Flexible Prices (IS-LM-AD):

A change in price level ($P$) shifts the LM curve ($M/P$).
Lower $P \implies$ higher $M/P \implies$ LM shifts right $\implies$ higher $Y$. This generates the Aggregate Demand (AD) curve.
Changes in fiscal/monetary policy shift the AD curve. The impact on $Y$ and $P$ depends on the Aggregate Supply (AS) curve.

Monetarism (Friedman):
- Money supply is the primary determinant of nominal GDP in the short run and price level in the long run.
- Emphasizes stable money growth rules instead of discretionary policy.
- Vertical long-run Phillips curve.
Natural Rate Hypothesis (Friedman & Phelps):
- There is a unique "natural rate of unemployment" (NAIRU) determined by labor market institutions.
- In the long run, monetary policy cannot systematically reduce unemployment below its natural rate; it only affects inflation.
- Short-run trade-off between inflation and unemployment exists due to adaptive expectations or nominal rigidities.

Adaptive Expectations: People form their expectations of future inflation based on past inflation. $ \pi_e = \pi_{t-1} $ or $ \pi_e = \sum \theta_i \pi_{t-i} $.
Short-Run AS Curve: Upward sloping, as unexpected inflation can lead firms to produce more (e.g., workers fooled into accepting lower real wages). Shifts with changes in expected inflation.
Policy Implications: In the short run, expansionary policy can reduce unemployment, but only if it creates unexpected inflation. As expectations adapt, the AS curve shifts, and the economy returns to the natural rate of unemployment at a higher inflation level.

Foreign Trade Multiplier:
- In an open economy, the multiplier effect of an autonomous spending change is smaller than in a closed economy due to leakages from imports.
- $ \text{Multiplier} = \frac{1}{1 - MPC(1-t) + MPM} $ where $MPM$ is the marginal propensity to import.
Twin Deficits: Refers to the simultaneous occurrence of a government budget deficit and a current account deficit.
- Identity: $ (S-I) +