Question

5. 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

The LM curve is vertical in a classical universe. This is because money demand is determined by production rather than interest rates. Taxation and government expenditure are successful fiscal policies because they ensure that production is distributed equitably.