Question

What would the LM curve look like in a classical world? If this really were the LM curve that 

we thought best characterized the economy, would we lean toward the use of fiscal policy or 

monetary policy? (You may assume your goal is to affect output.

Answer 1

In a classical world, the LM curve is vertical. This is because money demand depends on the level of output and not interest rates. Fiscal policy such as taxation and government spending is effective because it will ensure output is distributed evenly.