Suppose the Government of kenya decides to but securities from the members of the public in...

Suppose the Government of kenya decides to but securities from the members of the public in the economy. Show the impact of this policy on the IS-LM curve assuming that; 1. interest rate is constant 2. rate of interest is flexible 3. make a comment with reasons

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Expert Solution

1. when interest rate is constant , the LM curve is horizontal i.e people are willing to hold any amount of money at the going interest rate . In this case , increase in money supply as a result of buying of securities by the government will have no effect on output and interest rate . The equilibrium remains at point E where the interest rate is OR1 and output = OY1.

2. when interest rate is flexible , the LM curve is upward sloping In this case , increase in money supply as a result of buying of securities by the government causes the LM curve to shift right from LM to LM' . The equilibrium moves from point F to point G causing the interest rate to fall from OR1 to OR2 and output to increase from OY2 to OY3 .

3.When interest rate constant , output remains same because people will hold any amount of money at the going interest rate i.e LM curve is perfectly elastic so monetary policy is ineffective to affect output . On the other hand , the output increases when interest rate is flexible because with increase in money supply interest rate must fall to cause an increase in demand for money .

Rahul Sunny answered 1 year ago

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