Answer to Question #183155 in Macroeconomics for Nisha Chaudhary

Question

Explain the relationship between the effectiveness of monetary policy and the interest

elasticity of money demand. Will monetary policy be more or less effective the higher the

interest elasticity of money demand? Explain. Now explain the relationship between fiscal

policy and the interest elasticity of money demand. Why do the two relationships differ?

Answer 1

When money demand is interest elastic, the LM curve is flat but when monetary policy is applied the LM curve shifts to the right. Such a shift to the right increases income and decreases interest rate. Increase in income is insignificant and therefore in this case monetary policy is ineffective.

Facial policy and monetary policy are both used to control inflation by pursue policies of higher economic growth. The only difference between the two is that monetary policy is basically concerned with the management of interest rate and money supply while facial policy is a term used to explain the spending and tax actions of the federal government.