Question

For all of the questions below consider a closed economy. Make sure to include an
explanation for each question.
1) Using an IS-LM-FE framework analyze the consequences of the following event
according to a Keynesian economist. Central bank increases the money supply.

Answer 1

In IS-LM-FE framework, consider initially an economy is in equilibrium, goods market, labour market and money market is in equilibrium and initial rate of interest is r1 and when central bank increases the money supply in the economy through purchase of government bods & government securities this puts pressure on the interest rates and lower down the interest rates to r2 and resultantly LM curve shifts to the right and income will increase from Y1 to Y2 and lower rate of interest will increase the aggregate demand for goods and services than its aggregate supply and due to increased demand which is more than its supply.

Increase in money supply will decrease rate of interest, decrease in prices for goods and services and increase in aggregate demand for goods and services and national income will also increase.