Question

7. fiscal policy tool Show graphically that tax cuts are a more effective demand to interest rates. the greater is the sensitivity of money Show graphically that monetary policy is a less powerful tool the greater is the sensitivity of money demand to interest rates. 8.

Answer 1

Interest rate IS1 IS Income When the government increase spending and reduce tax will shift the IS curve to the right from IS to IS1. A tax cuts increase the disposable income and cause rise in consumption expenditure leading do an rise in money demand. this decreases the price and rise the interest rate. Thus, reduces in taxes and increases in government spending. Hence, there is excess liquidity with the people, government can purchase without less affecting money demand, the interest rate. Fiscal policy are more effective when tax cuts and greater sensivity of money demand to interest rate.