Assuming a horizontal LM, a smaller income-expenditure multiplier in the IS/LM model would, ceteris paribusGroup of answer choiceshave no impact on monetary policy effectiveness because this variable relates only to the IS functionmake monetary policy less effective in influencing output even though the sensitivity of expenditure to the interest rate is unchangedmake monetary policy less effective in influencing investment but more effective in influencing outputmake monetary policy more effective in influencing investment, but less effective in influencing output.
Question
Assuming a horizontal LM, a smaller income-expenditure multiplier in the IS/LM model would, ceteris paribusGroup of answer choiceshave no impact on monetary policy effectiveness because this variable relates only to the IS functionmake monetary policy less effective in influencing output even though the sensitivity of expenditure to the interest rate is unchangedmake monetary policy less effective in influencing investment but more effective in influencing outputmake monetary policy more effective in influencing investment, but less effective in influencing output.
Solution
The correct answer is: make monetary policy less effective in influencing output even though the sensitivity of expenditure to the interest rate is unchanged.
Here's the step by step explanation:
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The income-expenditure multiplier is a key component of the IS curve in the IS/LM model. It measures the change in aggregate output produced by a change in an autonomous expenditure.
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A smaller income-expenditure multiplier means that a change in autonomous expenditure will have a smaller impact on aggregate output.
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In the IS/LM model with a horizontal LM curve, monetary policy operates by changing the interest rate, which then affects investment and, through the multiplier, output.
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If the multiplier is smaller, a given change in the interest rate will have a smaller impact on output, even if the sensitivity of expenditure to the interest rate (the slope of the IS curve) is unchanged.
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Therefore, a smaller income-expenditure multiplier makes monetary policy less effective in influencing output.
Similar Questions
In the IS/LM model with a horizontal LM, an expansionary fiscal policy which does not push the economy beyond full-employmentGroup of answer choiceswould lead to a larger shift in the IS curve, the larger is the income –expenditure multiplierwould lead to some crowding-out if the central bank simultaneously undertakes a restrictive monetary policyshould have no effect on interest rates if monetary policy and the yield curve are unchangedall of the other alternatives are correct
The effectiveness of monetary policy in an IS-LM system increases when Group of answer choicesThe IS curve is flatterThe IS curve is steeperThe multiplier is smallerThe LM starts off at a higher level
Discuss the comparative effect of monetary and fiscal policy under the IS-LM framework
Consider the IS/LM model where the LM is horizontal. Suppose that the central announces an increase in its target cash rate. Other things being constant, this would result inGroup of answer choicesa shift up in the LM curve and a reduction in investment expenditurean unchanged LM curve and lower level of outputan unchanged LM curve, since the yield curve is unchanged, and lower outputa shift up in the LM curve and a higher level of output.
Consider the IS-LM model with interest-setting monetary policy. Explain the following: (a) the effect of an expansionary monetary policy on the equilibrium level of real income, the interest rate and the quantity of money; (b) the effect of an expansionary fiscal policy on the equilibrium level of real income, interest rates and the quantity of money. In view of your answer to part (a) identify the factors which in this model determine the effectiveness of monetary policy?
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