Answer to Question #256287 in Macroeconomics for Hansi

Question

"An inelastic LM line will make fiscal expansion less effective on output". Do you agree? Explain why.

Answer 1

I agree that an inelastic Lm line will make fiscal expansion less effective on output. First, LM line shows the relationships between asset markets and interest rates. For a general equilibrium to hold, a concurrent equilibrium between asset markets and goods must occur. Failure to have a general harmonious equilibria between the two creates an inelastic LM line. This causes fluctuations that at times is brought about by less money in circulation. Therefore, real high interest rates affects the general output and the general equilibria. An inelastic LM line makes it hard for fiscal ‘rescuing’ since it will be too late to inject government aid to correct the output. Fiscal expansion at this point doesn’t work to increase output from the general population or industrial output.