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Based on their beliefs about the slopes of the IS and LM curves, Monetarists argued that...

Based on their beliefs about the slopes of the IS and LM curves, Monetarists argued that the economy was inherently stable (insulated from demand shocks) and that monetary policy was very effective in changing real GDP in the short run. Using IS/LM analysis, explain and demonstrate graphically how Monetarists arrived at these conclusions.

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Answer #1

Monetarists believed that monetary policy has the ability to restore the economy at least in short run. They believed that the economy to works under the classical thought that is the LM curve need to be vertical. Is curve become interest elastic at near full employment situation. With a slight change in interest rate, the investment falls hence the IS does not play any role here. To restore the economy, monetary policy can play a vital role.

According to the diagram, Yf is the full employment level.IS cannot change as it is interest sensitive. So LM curve can shift either to right or left to restore the economy. If LM curve shifts to left then Yf can be achieved. So to shift leftwards, the money supply in the economy can be reduced.

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