FIGURE 11-8
Expected Deflation in the IS–LM Model An expected deflation (a negative value of
Eπ) raises the real interest rate for any given nominal interest rate, and this depresses investment spending. The reduction in investment shifts the
IS curve downward (measuring vertically, by an amount equal to the expected deflation). The level of income falls from
Y1 to
Y2. The nominal interest rate falls from
i1 to
i2, and the real interest rate rises from
r1 to
r2.