Question

In Macroeconomics, 2nd edition, williamson. Chapter 12: Keynesian Business Cycle, the sticky wage model.

Suppose that investment and consumption expenditure change very little with a change in the real interest rate. Show what this implies for the slope of the IS curve and AD curve, and for the relative effectiveness of monetary and fiscal policy in stabilizing real output. Explain your results.   

Answer 1

It is clear that investment and consumption are relatively less sensitive to change in real interest rate. Even fall in interest rate will not be able to push up real GDP in country.

The slope of IS or demand curve will be steep. It shows that if government uses monetary policy , it will not be effective enough to enhance real GDP of country;

Thus, government can use here fiscal policy to produce direct and maximum effects on real output of country. Since investment is less sensitive to change in interest rate, so there will be lesser impact on private investment or crowding out impact is likely to be mild.