Answer to Question #241015 in Macroeconomics for THEESAN

Question

Suppose that an economy is in a recession, and assume that the IS curve is relatively steep while the LM is relatively flat. If you were to advise policymakers on which action to take to overcome the recession, what would be your recommendation? Show the results graphically with an explanation. 

Answer 1

If the above situation i would recommend the policy makers to adopt the fiscal policy. The effect on the income of fiscal policy action is the largest when the LM schedule is relatively flat.

It indicates that fiscal policy is most effective when the interest rate inelasticity of money demand is high, making the LM schedule relatively flat; this concern concerns the interest-rate adjustment on investment after fiscal policy shift.

Expansionary fiscal policy, wll shift IS to IS₁ . Its intersection with LM raises income to Y*, which is greater than Y1 and represents full employment level thus fiscal policy will be the effective policy here.