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The monetary transmission mechanism in the IS-LM model is a process whereby an increase in the money supply increases the demand for goods and services by lowering the interest rate so that investment spending increases.
What happens to IS-LM model when money supply increases?
- With an increase in the money supply (actual money balances), the LM curve moves to the right (left) (decreases).
- Additionally, it moves left (right) as the need for money rises (decreases).
What happens to the IS-LM model when government spending increases?
- The LM curve is not directly impacted by fiscal policy.
- It is believed that borrowing will be used to pay for any increases in government spending or tax cuts.
- The LM curve remains unchanged because there is no change in the money supply.
How does the monetary transmission mechanism work?
- Through interest rate channels, the classic monetary transmission mechanism affects interest rates, borrowing costs, levels of physical investment, and aggregate demand.
- Additionally, the credit view, a source of friction in the credit markets, can have an impact on overall demand.
How does monetary policy affect demand?
- Monetary policy can be used to affect aggregate demand.
- The aggregate-demand curve will eventually move to the right as the money supply rises.
- The aggregate-demand curve will eventually move to the left as the money supply declines.
Learn more about monetary transmission mechanism here:
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