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Q: Draw the IS??LM model. Label the short run output and equilibrium interest rate a) \Animal...

Q: Draw the IS??LM model. Label the short run output and equilibrium interest
rate
a) \Animal spirits" was Keynes' explanation for random shifts in the IS curve
due to consumers' desire for consumption goods. An increase in consump-
tion shifts the IS curve to the right. What happens to short run output
and the equilibrium interest rate after this shift? What actions could the
Federal reserve take to keep the interest rate xed at its original level?

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Answer #1

The short run output and equilibrium interest rate both increase. This is shown in the graph below.
LM E2 E1 IS2 IS1

To keep the interest rate fixed, the Fed can increase the money supply. This would shift the LM curve to the right and bring interest rate back to initial level.

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