Now that you understand how the IS curve and the LM curve are
derived and what makes them shift, let's start using them to
make some economic predictions. In the early 1990s, the United
States was going through a recession. The Federal Reserve
responded by increasing the money supply.
- Is the IS curve or the LM curve affected by an increase
in the money supply ?
- How do you think an increase in the money supply will
affect the LM curve ?
- How does increasing the money supply affect output and
interest rates ?
- Given your answer to Question 3, why do financial markets
care what the Chairman of the Federal Reserve says ?
- If the economy is projected to slip into a recession next
year and you plan to buy a house this year, should you
get a fixed rate mortgage (your interest rate will not
change) or a flexible rate mortgage (your interest rate
will fluctuate according to changes in market interest
rates) ?