Question

Q1. Suppose policy makers in a closed economy are concerned about inflation and want to increase the interest rate without changing the level of real GDP. What kind of policy mix would you recommend and how would your policy mix affect the components of GDP? Explain your answer and the adjustment processes that take place with the help of an IS-LM diagram.

Answer 1

The policymakers should use a mix of expansionary fiscal (rise in government spending) and contractionary monetary (increase in interest rate) policies to increase interest rate without change in real GDP.