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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: a. by increasing government spending on goods and services. b. by lowering the interest rate so that investment spending increases. c. directly. d. by raising the interest rate so that investment spending increases.

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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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