Answer to Question #234698 in Macroeconomics for Nald

Question

Using the IS–LM model, determine the impact on stock prices of each of the policy changes
described below. If the effect is ambiguous, explain what additional information would be needed
to reach a conclusion.
a) An unexpected expansionary monetary policy with no change in fiscal policy.
b) A fully expected expansionary monetary policy with no change in fiscal policy.
c) A fully expected expansionary monetary policy together with an unexpected expansionary fiscal
policy.

Answer 1

a) During the short- run, the surprise shifts down of the LM curve shows that there is an unexpected decrease in interest rate while on the other hand there is an unexpected increase in income (Y). Stock prices would increase.

b) The LM curve shifts downwards when there is an expansionary monetary policy. When this happens, an increase in money supply is seen followed by a fall in interest rate. On the other hand, the economy is seen to move down along the IS curve. Consequently, the fall in the interest rate causes a rise in investment demand, which has a multiplier effect on consumption.

c) On this, the expansionary fiscal policy causes a shift of the IS curve to the right side while the multiplier effect on consumption results in a raise of products and the national income. The increased interest rate partially offsets the expansionary effect. This is followed by an increase in the supply of money and a fall in the interest rate. Then the economy is seen to move downward along the IS curve.