Answer to Question #213475 in Macroeconomics for Sumitra Nandini

Question

. if investment is very interest enclantic , moot of an income tax wake cut will be created out, therefore, the central bank should always supplements a tax cut with an increase is money gupply comment on this patement with the help of an is-lm diagram and explain the adjustment wold your answer change in the propere. porice. danfarce allowed to change explain.

Answer 1

LM curve shifts to the right in the short run when the money supply increases, thereby moving the economy from point A to B. Interest rates fall from r1 to r2, thereby stimulating investment as output increases from Y to Y2.

Prices begin to increase because the output is above the long-run, decreasing real balances as interests arise. The prices continue to rise till it reaches the actual point A. interest rates and investments also return to the original level. However, there is no impact on real variables from the increase in money supply in the long run.