Answer to Question #63316 in Microeconomics for Mage

Question

Fiscal policy needs monetary policy to be fully effective. Illustrate this statement using the IS-LM model

Answer 1

In some cases fiscal policy needs also monetary policy to be effective.
For example, when there is unemployment in the economy so that there is possibility of increases in output as a result of increase in aggregate demand. In this case interest rate need not rise when there is increase in government spending shifting IS curve to the right but at the same time the Central Bank of the country raises the money supply to prevent the rise in interest as a result of increase is government spending. This is called monetary accommodation by the Central Bank.