In the IS-LM model when the Federal Reserve decreases the money supply, people b
ID: 1196437 • Letter: I
Question
In the IS-LM model when the Federal Reserve decreases the money supply, people bonds and the interest rate , leading to a(n) in investment and income. If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the money supply constant, then the two policies together would generally lead to income and a interest rate. According to the macroeconometric model developed by Data Resources Incorporated, if taxes are increased by SI 00 billion, but the money supply is held constant, then GDP will fall by about: The aggregate demand curve generally slopes downward and to the right because, for any given money supply M a higher price level P causes a real money supply M/Py which the interest rate and spending. An increase in the money supply shifts the curve to the right, and the aggregate demand curve . In a small open economy with perfect capital mobility, if the domestic interest rate were to rise above the world interest rate, then would drive the domestic interest rate back to the level of the world interest rate. In a small open economy with a floating exchange rate, an effective policy to increase equilibrium output is to:Explanation / Answer
1.) People sell bonds, as they need money for transactional demand. So they sell bonds to obtain money for transactional purposes. The decrease in money supply leads to increase in interest rate as now more bond sellers are there. Thus higher interest rate has to be offered to sell bonds. This leads to decrease in investment as increase in interest rate causes the cost of capital to rise, hence investment in economy decrease. This leads to fall in Y and thus correspondingly fall in consumption.
2.) This can viewed as downward shift of IS curve in IS-LM model. This leads to fall in income and interest rate.
Intuitively, the increase in taxes leads to decrease in disposable income and hence fall in consumption which in turn leads to fall in output. Due to lower income, the transaction demand for money decrease, thereby interest rate increase.
3.) Missing Data
4.) Real Money Supply = Nominal Money Supply / Price = M/P. Hence increase in P decreases Real money suply.
From LM Equation this requires fall in right side. This reduces income and hence consumption and increases the interest rate.