Question

Briefly explain whether and if so how an increase in the federal funds rate affects the (i) IS curve, (ii) the LM curve, and (iii) the Phillips curve.

Answer 1

a) An increase in the Federal fund rate will not have much effect on the IS curve but will only cause a movement along the IS curve, as the output will decrease and the interest rate will rise.

b) LM curve will shift to the left as the money supply in the market will decrease, the interest rate will increase and the output in the market will fall at a higher interest rate.

c) This will cause a movement along the Philip curve and the inflation will fall and the unemployment in the market will fall.