If you believe that the IS curve slopes up, then what the Bank of Canada says about "monetary policy accommodation" makes sense. If you believe the IS curve slopes down, like in the textbooks, then it doesn't make sense.

This is supposed to be a simple teaching post. My own mind is pretty simple anyway.

The IS equation is D(Y,r)=Y, where D is output demanded (desired expenditure), which depends positively on actual output (=income) Y, and negatively on the real interest rate r.

If we take the total derivative of the IS equation D_{y}dY+D_{r}dr=dY, and rearrange, we get the slope of the IS curve as dr/dY= (1-D_{y})/D_{r}. The textbook assumes that 0 < D_{y} < 1, so the IS curve has a negative slope, because D_{r} < 0. If instead we assume D_{y} > 1, we get a positive slope. And if firms don't want to invest when output is low and there is lots of spare capacity, this assumption that D_{y} > 1, and so the IS curve has a positive slope, may be plausible.

Define the natural rate of interest r* as the solution to D(Y*,r*)=*Y***, where Y* is "potential output" -- the level of output consistent with inflation staying at the 2% target.

If there is a recession, so Y < Y**, *then the Bank of Canada will need to set r below r* just to prevent Y falling even further below Y*, and set r even lower still to get Y to grow back to Y*. The Bank of Canada calls this "monetary policy accommodation".

Here's a picture:

It's more complicated than this of course. It always is. Expectations of future interest rates, output, inflation, and exchange rates, matter too. And it may take time for output and expectations to adjust. The natural rate of interest moves around over time, and a loss of "business confidence" (firms fear demand won't be there to justify investment) may take time to recover. And the IS curve might not slope up everywhere -- it might slope down at very low levels of Y, when gross investment is already zero and can't fall any further. But I think that's the gist of it.

And yes, if the Bank of Canada just sets an interest rate and holds it constant regardless of what happens to output and inflation (so the LM curve is horizontal forever) this is an unstable system (so resist the temptation to say that an upward-sloping IS curve means that if the Bank of Canada cuts the rate of interest this will cause a recession). But the Bank of Canada doesn't do that.

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