Answer to Question #221242 in Macroeconomics for Critical

Question

1. With the aid of a diagrams, briefly explain how interest elasticities and demand for money affect the slope of the IS and the LM curve.

2.With the aid of diagrams, brieftly explain the effectiveness of fiscal and monetary policy under fixed exchange rate system with perfect capital mobility within the IS-LM-BOP framework.

Answer 1

1.

The larger the income-elasticity, and the lower the interest-elasticity of the demand for money, the steeper the LM curve will be. In case the demand for money is relatively insensitive to the interest rate, the LM curve is nearly vertical.

2.

The Fed's response causes an increase in the money supply, which in turn will lower interest rates back to their original level. ... The final result is that expansionary fiscal policy in a fixed exchange rate system will cause an increase in GNP (from Y ¹ to Y ²) and no change in the exchange rate in the short run.