Answer to Question #218552 in Macroeconomics for lex

Question

Answer the following questions (3 points , 1.5 each):

a. What would the LM curve look like in the classical world? If this was the actual case

what would a policymaker prefer to affect output, monetary or fiscal policy?

b. Suppose there is a decline in demand for money. At each output level and interest rate

the public wants to hold lower real balances

i. In the Keynesian case, what happens to equilibrium output and to prices?

ii. In the classical case what is the impact on output and prices?

Answer 1

a) In the event that money demand doesn't depend on the rate of interest, the LM curve is vertical.

When fiscal policy is used, higher taxes are involved which lower spending. Therefore most economies prefer monetary policy in the economy 'fine-tuning'.