Question

Suppose that MD is insensitive to the interest rate. What does the LM curve look like (graphically)? What is the effect on output and interest rates from a shift in the IS curve? Suppose that MD is very sensitive to the interest rate. What does the LM curve look like (graphically)? What is the effect of a shift in the IS curve on output and interest rates? Suppose that AD is very sensitive to the interest rate. Draw the IS curve and describe the effects from a shift in the LM curve a. b. c. d. Suppose that the interest rate has a negligible effect on AD. What does the IS curve look like (graphically)? What are the effects of shifts in the LM curve?

Answer 1

1. In case the demand for money is relatively insensitive to the interest rate, the LM curve is nearly vertical

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And the LM curve will shift left during panics, raising interest rates and decreasing output, because demand for money increases as economic agents scramble to get liquid in the face of the declining and volatile prices of other assets, particularly financial securities with positive default risk.

These are changes that are not related to output or interest rates, which merely indicate movements along the IS curve.