Answer to Question #155050 in Macroeconomics for Suga

Question

By using the IS-LM model, if the money demand is sensitive to interest rate and the investment is not sensitive at all to interest rate, monetary policy is more effective compared to fiscal policy. Right or wrong? Prove it

Answer 1

Wrong.

If money demand is very sensitive to the interest rate, then fiscal policy is very effective. The LM curve moves horizontally. The output increases with the shift in the IS curve. Monetary policy is completely ineffective: an increase in money supply has no effect on the LM curve.

The LM curve shows the relationship between income and the interest rate at which the supply and demand are equal. Therefore the money market is in equilibrium.