Question

1) Suppose the central bank pursues restrictive monetary policy. Then:

a. The IS curve shifts right

b. The IS curve shifts left

c. The LM curve shifts right

d. The LM curve shifts left

2. Which of the following would not cause the IS curve to shift to the left?

a. a decrease in government expenditures

b. a decrease in the money supply

c. an increase in the domestic price level

d. an increase in taxes

3)Under fixed exchange rates, when a central bank increases money supply, it first shifts the LM curve to the ______ and later shifts ______.

a. left; the LM curve to the right.

b. left; the IS curve to the right.

c. right; the LM curve to the left.

d. right; the IS curve to the right.

Answer 1

Ans 1: (D) because LM curve is a money market curve and a restrictive policy means decreasing the money supply into the economy, would shift the LM curve to left. The IS curve is a goods market equilibrium and shifts due to changes in government expenditure.

Ans 2: (B) because a decrease in the money supply would shift the LM curve to the left and not affect the IS curve.

Ans 3: (C) because under fixed exchange rate and perfect capital mobility, monetary policy is ineffective in raising output level. An increase in money supply shift the LM curve to the right, exchange rate starts rising, domestic currency starts depreciating, to keep the exchange rate fixed, the LM curve shift to left.