Answer to Question #94979 in Macroeconomics for Prakash

Question

Explain through appropriate IS-LM curves the type of monetary and fiscal policies a government should take to deal with recession in an open economy

Answer 1

It may be noted that the impact of monetary and fiscal policies in the IS-LM model depends also on interest elasticity of the transaction demand for money.

If transactions demand for money becomes sensitive to interest rate changes, as has been postulated by W. J. Baumol and James Tobin, monetary policy loses its effectiveness and fiscal policy becomes more powerful as a stabilisation weapon.