How does the IS-LM model illustrate monetary and fiscal policy equilibrium?

The IS-LM model (formulated by John Hicks and Alvin Hansen) synthesizes the goods market and the money market.

Key Equations:

• IS Curve (Investment-Savings): Represents equilibrium in the goods market ($Y = C + I + G$). It slopes downward because a lower interest rate ($r$) stimulates investment demand, increasing aggregate output ($Y$).
• LM Curve (Liquidity Preference-Money Supply): Represents equilibrium in the money market ($M/P = L(Y, r)$). It slopes upward because higher output increases transaction demand for money, requiring higher interest rates to restore money market equilibrium.

Policy Implications:

1. Expansionary Fiscal Policy: Shifts the IS curve rightward, raising output and interest rates (subject to crowding-out effects).
2. Expansionary Monetary Policy: Shifts the LM curve rightward, lowering interest rates and raising output.