Question

After the global financial crisis several European economies adopted quantitative easing, better known as QE. Quantita- tive easing is an expansionary monetary policy used by the central bank, to buy financial assets from distressed com- mercial banks and large private institutions to facilitate the flow of credit in the financial markets. If QE proves to be successful, interest rates would decline, hence inducing in- creased investment and higher output. What is the effect on the IS-LM model?

Answer 1

Ans. Quantitave easing will increase the money supply in the economy. So, the LM curve will shift rightwards from LM to LM'. The increase in money supply will lead to decrease in interest rate from r to r'. This decreases the cost of borrowing which induces the investment spending in the economy, increasing the real GDP along the IS curve. So, this increases the real GDP from Y to Y'.

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