Question

If Federal Reserve decides to decrease the money supply in the United States, what will happen to: (1) the interest rate; (2) the level of investment spending in America; (3) the level of GDP; (4) the level of money demand; (3) the U.S interest rate; (4) the level of U.S. Investment spending. In your answer, please draw the changes in the IS Curve and the LM Curve if there are any.

Answer 1

The decrease in money supply shifts the LM curve to the left from LM to LM'. As a result, the interest rate will be increased. High-interest rate discourages investment spending which is adverse for the economy. A high-interest rate increases the cost of borrowing which discourages business to increase investment spending. The level of GDP decreases from Y1 to Y2. At the high-interest rate, people try to save more so money demand is decreased.

1. The interest rate is increased

2. The level of investment spending decreases.

3. the level of GDP decreases

4. The level of money demand decreases

5. The US interest rate increases

6. The level of US investment spending decreases

7.