The LM Curve and Monetary Policy

Question 1

What determines the slope of the LM curve?

Answer 1

The sensitivity of money demand to interest rates.

Question 2

How does an increase in the money supply affect the LM curve?

Answer 2

It shifts the LM curve to the right, lowering interest rates and increasing income/output.

Question 3

How does a decrease in the money supply affect the LM curve?

Answer 3

It shifts the LM curve to the left, raising interest rates and lowering income/output.

Question 4

What is monetary policy?

Answer 4

Central bank actions controlling money supply and interest rates to influence the economy.

Question 5

What happens when the central bank raises interest rates?

Answer 5

Investment declines, shifting the LM curve leftward.

Question 6

What is the effect of expansionary monetary policy in the IS-LM model?

Answer 6

It shifts the LM curve rightward, lowering interest rates and increasing income/output.

Question 7

What is the effect of contractionary monetary policy in the IS-LM model?

Answer 7

It shifts the LM curve leftward, raising interest rates and reducing income/output.

Question 8

Why does monetary policy impact the LM curve?

Answer 8

Because money supply influences liquidity preferences and interest rates.

Question 9

When is monetary policy most effective in the IS-LM model?

Answer 9

When the IS curve is relatively steep (investment insensitive to interest rates).

Question 10

What happens to the IS-LM equilibrium if both monetary and fiscal policy are expansionary?

Answer 10

Both curves shift right, significantly increasing income/output, with uncertain effects on interest rates.