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4. Suppose that the main source of uncertainty in the economy is the position of the...

4. Suppose that the main source of uncertainty in the economy is the position of the IS curve. Use a pair of IS-LM diagrams to discuss whether money supply targeting or interest rate targeting is more effective in this situation.

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Answer #1

In case of money supply targeting, the LM curve shifts, changing the income levels in the economy (figure 1). In interest rate targeting, the IS curve shifts as a result of change in investment and consumption. This is shown in figure 2. Suppose the income levels are to be increased in the economy, either the money supply is increased or the interest rate is reduced. Since the position of the IS curve is the main source of uncertainty in the economy, interest rate targeting is more risky Therefore, money supply targeting is more effective in the economy.

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