Question

Suppose there is a simultaneous reduction in the expected future interest rate and increase in future expected output. This will cause which of the following to occur?

1 The IS curve to shift left in the current period

2 The IS curve to shift right in the current period

3 The LM curve to shift up in the current period

4 The LM curve to shift down in the current period

Answer 1

A reduction in the expected interest rate in the future and an increase in future expected output would encourage the borrowers of loanable funds or the individuals, households, firms or businesses, etc. to postpone their financial borrowings to finance or liquidate their consumption expenditures and business investment expenditures. This would essentially lead to a reduction in the overall or total money demand in the money or loanable funds market during the current time period as the interest rate or the cost of financial borrowing would expectedly fall in the future leading to lower periodic interest payments on any financial loan or borrowing in the future compared to the current time period. This would cause the LM curve in the IS-LM graphical model to shift to the right or down signifying a reduction in the present interest rate. Now, holding the total money supply in the money or loanable funds market constant, a reduction in the money demand in the current time period due to the expected reduction in future interest rate would cause a reduction in the current interest rate which would also be reflected in the IS-LM graphical model as the LM curve shifts to the right or downward as the money demand decreases in the money or loanable funds market, holding everything else as constant. Therefore, the answer, in tis case, would option 4 given among the answer choices or options or The LM curve to shift down in the current period.