Determine whether each of the following statements is true or false, and explain why
Determine whether each of the following statements is true or false, and explain why. For each true statement, discuss the impact of monetary and fiscal policy in that special case.
a. If investment does not depend on the interest rate, the LM curve is horizontal.
b. If investment does not depend on the interest rate, the IS curve is vertical.
c. If money demand does not depend on the interest rate, the IS curve is horizontal.
d. If money demand does not depend on the interest rate, the LM curve is vertical.
e. If money demand does not depend on income, the LM curve is horizontal.
f. If money demand is extremely sensitive to the interest rate, the LM curve is horizontal.
Homework Answers
a. False
The LM curve is not dependent on investment in any way. It comprises of demand for real money and interest rate. So, the amount of investment will have no impact on the LM curve.
b. True
If investment is not dependent on interest rate , it means investment will not change as interest changes and then the IS curve will be vertical.
A shift in the LM curve due to a monetary policy will only change interest rate and not the GDP. Hence, the policy is ineffective.
However, a fiscal policy will shift the IS curve and have some effect.
c. False
The IS curve is dependent on GDP ( C+I+G) and interest , since the component of money demanded does not impact the IS curve. So, whether money demand is dependent on interest rate or not will not impact the slope of the IS curve.
d. True
If money demand is not dependent on interest rate, then at any given interest rate the money demand will be the same so the LM curve will vertical.
Suppose , the IS curve shifts because of a fiscal policy, here there will be no change in the GDP only a change in the interest rate . So, in this case the interest rate will rise and at the same time investment will fall by an equal amount to the change in IS curve.
So, use of fiscal policy will just increase the interest rate and no change in the output. Hence, will be ineffective in bringing any change.
A monetary policy will shift the LM curve and have some impact.
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