Mishkin 6ce TB Ch28

Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 28 Web Chapter 2: The ISLM Model
28.1 Keynes's Fixed Price Level Assumption and the IS Curve
1) The key assumption in the ISLM model is that ________.

A) the price level is fixed
B) the inflation rate is zero
C) there is no role for interest rates
D) A and B only.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: Web Chapter 2: The ISLM Model
2) The money market is in equilibrium ________.

A) at any point on the IS curve
B) at any point on the LM curve
C) at only one point on the LM curve
D) only at the intersection of the IS and LM curves
Answer: B
Diff: 2 Type: MC
Skill: Recall
3) The ________ describes the combinations of interest rates and aggregate output for which
the quantity of money demanded equals the quantity of money supplied.
A) IS curve
B) LM curve
C) consumption function
D) investment schedule
Answer: B
Diff: 2 Type: MC
Skill: Recall
4) In the Keynesian model the quantity of money demanded is ________ related to income and
________ related to the interest rate.
A) positively; positively
B) positively; negatively
C) negatively; negatively
D) negatively; positively
Answer: B
Diff: 2 Type: MC
Skill: Recall
1
Copyright 2017 Pearson Canada, Inc.
5) According to the liquidity preference theory, the demand for money is ________ related to
aggregate output and ________ related to interest rates.
A) negatively; negatively
B) negatively; positively
C) positively; negatively
D) positively; positively
Answer: C
Diff: 2 Type: MC
Skill: Recall
6) As interest rates rise, the opportunity cost of holding money ________ and the quantity of
money demanded ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls
Answer: B
Diff: 2 Type: MC
Skill: Recall
7) As aggregate output rises, the demand for money ________ and the interest rate ________,
so that money demanded equals money supplied and the money market is in equilibrium.
A) increases; rises
B) increases; falls
C) decreases; rises
D) decreases; falls
Answer: A
Diff: 2 Type: MC
Skill: Recall
8) Everything else held constant, if aggregate output is to the right of the LM curve, then there
is an excess ________ of money which will cause the interest rate to ________.
A) supply; fall
B) supply; rise
C) demand; fall
D) demand; rise
Answer: D
Diff: 2 Type: MC
Skill: Recall
2
9) Everything else held constant, if aggregate output is to the left of the LM curve, then there is
an excess ________ of money which will cause the interest rate to ________.
A) supply; fall
B) supply; rise
C) demand; fall
D) demand; rise
Answer: A
Diff: 2 Type: MC
Skill: Recall
10) Everything else held constant, if aggregate output is to the ________ of the LM curve, then
there is an excess supply of money which will cause the interest rate to ________.
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Answer: C
Diff: 2 Type: MC
Skill: Recall
there is an excess demand of money which will cause the interest rate to ________.
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Answer: B
Diff: 2 Type: MC
Skill: Recall
there is an excess ________ of money which will cause the interest rate to fall.
A) right; supply
B) right; demand
C) left; supply
D) left; demand
Answer: C
Diff: 2 Type: MC
Skill: Recall
3
there is an excess ________ of money which will cause the interest rate to rise.
A) right; supply
B) right; demand
C) left; supply
D) left; demand
Answer: B
Diff: 2 Type: MC
Skill: Recall
14) Describe the key assumption that drives Keynes's ISLM model.
Answer: Keynes analysis was created during the Great Depression period when inflation was
not serious. As a result of this, Keynes assumed that the price level is fixed and therefore
inflation is zero. The real interest rate equals the nominal interest rate and there is no need to
distinguish between the two.
Diff: 2 Type: ES
Skill: Recall
28.2 ISLM Approach to Aggregate Output and Interest Rates
1) Macroeconomic equilibrium requires ________.

A) equilibrium in the goods market
B) equilibrium in the money market
C) equilibrium in both the goods and money markets
D) equilibrium in neither the goods nor the money market
Answer: C
Diff: 2 Type: MC
Skill: Recall
2) When the IS and LM curves are combined in the same diagram, the intersection of the two
curves determines the equilibrium level of ________ as well as the ________.
A) aggregate output; price level
B) aggregate output; interest rate
C) money supply; price level
D) consumer expenditures; interest rate
Answer: B
Diff: 2 Type: MC
Skill: Recall
4
3) If the economy is on the LM curve, but is to the right of the IS curve, aggregate output will
________ and the interest rate will ________.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: D
Diff: 2 Type: MC
Skill: Applied
4) If the economy is on the LM curve, but is to the left of the IS curve, aggregate output will
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: A
Diff: 2 Type: MC
Skill: Recall
5) If the economy is on the IS curve, but is to the left of the LM curve, aggregate output will
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: B
Diff: 2 Type: MC
Skill: Applied
6) If the economy is on the IS curve, but is to the right of the LM curve, aggregate output will
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: C
Diff: 2 Type: MC
Skill: Applied
5
7) If the economy is on the IS curve, but is to the left of the LM curve, then the ________
market is in equilibrium, but the interest rate is ________ the equilibrium level.
A) goods; below
B) goods; above
C) money; below
D) money; above
Answer: B
Diff: 2 Type: MC
Skill: Applied
8) If the economy is on the LM curve, but is to the right of the IS curve, then the ________
market is in equilibrium, but aggregate ________ exceeds aggregate ________.
A) goods; output; demand
B) goods; demand; output
C) money; output; demand
D) money; demand; output
Answer: C
Diff: 2 Type: MC
Skill: Applied

Answer: B
Diff: 2 Type: MC
Skill: Recall
A) IS curve
B) LM curve
Answer: B
Diff: 2 Type: MC
Skill: Recall
6
11) In the Keynesian model the quantity of money demanded is ________ related to income
and ________ related to the interest rate.
Answer: B
Diff: 2 Type: MC
Skill: Recall
Answer: C
Diff: 2 Type: MC
Skill: Recall
13) As interest rates rise, the opportunity cost of holding money ________ and the demand for
money ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls
Answer: B
Diff: 2 Type: MC
Skill: Recall
A) increases; rises
B) increases; falls
C) decreases; rises
D) decreases; falls
Answer: A
Diff: 2 Type: MC
Skill: Recall
7
A) supply; fall
B) supply; rise
C) demand; fall
D) demand; rise
Answer: D
Diff: 2 Type: MC
Skill: Recall
16) Everything else held constant, if aggregate output is to the left of the LM curve, then there
A) supply; fall
B) supply; rise
C) demand; fall
D) demand; rise
Answer: A
Diff: 2 Type: MC
Skill: Recall
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Answer: C
Diff: 2 Type: MC
Skill: Recall
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Answer: B
Diff: 2 Type: MC
Skill: Recall
8
A) right; supply
B) right; demand
C) left; supply
D) left; demand
Answer: C
Diff: 2 Type: MC
Skill: Recall
A) right; supply
B) right; demand
C) left; supply
D) left; demand
Answer: B
Diff: 2 Type: MC
Skill: Recall
21) Discuss the IS-LM curves and how the equilibrium in the goods and money market is
achieved.
Answer: The IS curve shows the combination of interest rates and aggregate output such that
the goods market is in equilibrium. The LM curve shows combinations of interest rates and
output such that the money market is in equilibrium. At the intersection of the IS-LM curves is
the interest rate and aggregate output that BOTH the goods and money markets are both in
equilibrium and ceteris paribus, there is no pressure to move from that point. At any other
point, one of the markets is not in equilibrium and there is pressure to move towards the IS-LM
intersection.
Diff: 2 Type: ES
Skill: Recall
9
28.3 Factors That Cause the LM Curve to Shift

Answer: B
Diff: 2 Type: MC
Skill: Recall
A) IS curve
B) LM curve
Answer: B
Diff: 2 Type: MC
Skill: Recall
3) In the Keynesian model the quantity of money demanded is ________ related to income and
________ related to the interest rate.
Answer: B
Diff: 2 Type: MC
Skill: Recall
Answer: C
Diff: 2 Type: MC
Skill: Recall
10
5) As interest rates rise, the opportunity cost of holding money ________ and the demand for
money ________.
A) rises; rises
B) rises; falls
C) falls; rises
D) falls; falls
Answer: B
Diff: 2 Type: MC
Skill: Recall
A) increases; rises
B) increases; falls
C) decreases; rises
D) decreases; falls
Answer: A
Diff: 2 Type: MC
Skill: Recall
A) supply; fall
B) supply; rise
C) demand; fall
D) demand; rise
Answer: D
Diff: 2 Type: MC
Skill: Recall
8) Everything else held constant, if aggregate output is to the left of the LM curve, then there is
an excess ________ of money which will cause the interest rate to ________.
A) supply; fall
B) supply; rise
C) demand; fall
D) demand; rise
Answer: A
Diff: 2 Type: MC
Skill: Recall
11
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Answer: C
Diff: 2 Type: MC
Skill: Recall
A) right; fall
B) right; rise
C) left; fall
D) left; rise
Answer: B
Diff: 2 Type: MC
Skill: Recall
A) right; supply
B) right; demand
C) left; supply
D) left; demand
Answer: C
Diff: 2 Type: MC
Skill: Recall
A) right; supply
B) right; demand
C) left; supply
D) left; demand
Answer: B
Diff: 2 Type: MC
Skill: Recall
12
13) If the money supply increases, everything else held constant, the ________ curve shifts to
the ________.
A) IS; right
B) IS; left
C) LM; left
D) LM; right
Answer: D
Diff: 2 Type: MC
Skill: Recall
14) If the money demand decreases, everything else held constant, the ________ curve shifts to
the ________.
A) IS; right
B) IS; left
C) LM; left
D) LM; right
Answer: C
Diff: 2 Type: MC
Skill: Recall
28.4 Changes in Equilibrium Level of the Interest Rate and Aggregate Output
1) In the ISLM framework, an expansionary monetary policy causes aggregate output to

________ and the interest rate to ________, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: B
Diff: 2 Type: MC
Skill: Recall
2) An expansionary monetary policy shifts the LM curve to the ________, reducing ________,
everything else held constant.
A) left; output and increasing interest rates
B) left; both real output and interest rates
C) right; both interest rates and real output
D) right; interest rates and increasing real output
Answer: D
Diff: 2 Type: MC
Skill: Recall
13
3) Everything else held constant, a monetary expansion is characterized by ________ output
and ________ interest rates.
A) rising; rising
B) rising; falling
C) falling; rising
D) falling; falling
Answer: B
Diff: 2 Type: MC
Skill: Recall
4) A contractionary monetary policy shifts the LM curve to the ________, reducing ________,
everything else held constant.
A) left; output and increasing interest rates
B) left; both real output and interest rates
C) right; both interest rates and real output
D) right; interest rates and increasing real output
Answer: A
Diff: 2 Type: MC
Skill: Recall
5) Everything else held constant, a monetary contraction is characterized by ________ output

and ________ interest rates.
A) rising; rising
B) rising; falling
C) falling; rising
D) falling; falling
Answer: C
Diff: 2 Type: MC
Skill: Recall
6) In the money market, a condition of excess demand for money can be eliminated by a
________ in aggregate output or a ________ in the interest rate, everything else held constant.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: C
Diff: 2 Type: MC
Skill: Recall
14
7) In the money market, a condition of excess supply of money can be eliminated by a
________ in aggregate output or a ________ in the interest rate, everything else held constant.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: B
Diff: 2 Type: MC
Skill: Recall
8) In the ISLM framework, an expansionary fiscal policy causes aggregate output to ________
and the interest rate to ________, everything else held constant.
Answer: A
Diff: 2 Type: MC
Skill: Recall
9) In the ISLM framework a contractionary fiscal policy causes aggregate output to ________
and the interest rate to ________, everything else held constant.
Answer: C
Diff: 2 Type: MC
Skill: Recall
10) Everything else held constant, an expansionary ________ policy will cause the interest rate
to rise, while an expansionary ________ policy will cause the interest rate to fall.
A) monetary; monetary
B) monetary; fiscal
C) fiscal; monetary
D) fiscal; fiscal
Answer: C
Diff: 2 Type: MC
Skill: Recall
15
11) Aggregate output and the interest rate are ________ related to government spending and
are ________ related to taxes.
C) negatively; positively
D) negatively; negatively
Answer: B
Diff: 2 Type: MC
Skill: Recall
12) An increase in spending that results from expansionary ________ policy causes the interest
rate to ________, everything else held constant.
A) fiscal; rise
B) fiscal; fall
C) incomes; rise
D) incomes; fall
Answer: A
Diff: 2 Type: MC
Skill: Recall
13) Despite an expansionary monetary policy, an economy experiences a recession. Everything

else held constant, the recession could occur in spite of the rightward shift of the LM curve if
________.
A) consumer confidence decreases sharply
B) there is an investment boom
C) the money supply increases
D) taxes are cut
Answer: A
Diff: 2 Type: MC
Skill: Recall
14) If an economy experiences high interest rates and high unemployment, the ISLM
framework predicts that ________ policy has been too ________.
A) fiscal; expansionary
B) fiscal; contractionary
C) monetary; expansionary
D) monetary; contractionary
Answer: D
Diff: 2 Type: MC
Skill: Recall
16
15) Which of the following statements concerning Keynesian ISLM analysis is true?
A) For a given change in taxes, the IS curve will shift less than for an equal change in
government spending.
B) Changes in net exports arising from a change in interest rates causes a shift in the IS curve.
C) A fall in the money supply shifts the LM curve to the right.
D) Expansionary fiscal policy will cause the interest rate to fall.
Answer: A
Diff: 2 Type: MC
Skill: Recall
16) Referring to the Economic Stimulus Act of 2008, the expansionary effect of the
government stimulus was overwhelmed by the continuing deterioration in credit market
conditions. Everything else held constant and using the ISLM model, the net effect would cause
the ________ curve to ________ and output will ________.
A) IS; shift left; decrease
B) IS; shift right; increase
C) LM; shift right; increase
D) LM; shift left; decrease
Answer: A
Diff: 2 Type: MC
Skill: Recall
17) Using the ISLM model, explain the effects of a monetary expansion combined with a fiscal
contraction. How do the equilibrium level of output and interest rate change?
Answer: The monetary expansion shifts the LM curve to the right which by itself would cause
the interest rate to decrease and aggregate output to increase. The fiscal contraction shifts the
IS curve to the left which by itself would cause the interest rate to decrease and aggregate
output to decrease. Therefore, the equilibrium interest rate unambiguously falls, while the effect
on output is indeterminate.
Diff: 2 Type: ES
Skill: Recall
17
18) Using the ISLM model, show graphically and explain the effects of a monetary contraction.
What is the effect on the equilibrium interest rate and level of output?
Answer: See figure below.
The monetary contraction shifts the LM curve to the left. The result is that the equilibrium level
of output falls and the equilibrium interest rate increases.
Diff: 2 Type: ES
Skill: Recall
18
28.5 Effectiveness of Monetary Policy Versus Fiscal Policy
1) The situation in which expansionary fiscal policy does not lead to a rise in aggregate output
is referred to as ________.
A) fiscal neutrality
B) a recession
C) complete crowding out
D) inflation
Answer: C
Diff: 2 Type: MC
Skill: Recall
2) If the quantity of money demanded is not affected by changes in the interest rate, the LM
curve is ________ and fiscal policy will be ________.
A) horizontal; very effective
B) horizontal; ineffective
C) vertical; ineffective
D) vertical; very effective
Answer: C
Diff: 2 Type: MC
Skill: Recall
3) The LM curve will be vertical and fiscal policy ineffective when ________.
A) the demand for money is unaffected by changes in the interest rate
B) the demand for money is unaffected by changes in income
C) investment is unaffected by changes in the interest rate
D) investment is unaffected by changes in income
Answer: A
Diff: 2 Type: MC
Skill: Recall
4) The situation in which expansionary fiscal policy does not lead to a rise in aggregate output
is referred to as ________.
A) fiscal neutrality
B) a recession
C) complete crowding out
D) inflation
Answer: C
Diff: 2 Type: MC
Skill: Recall
19
5) Crowding out will be more pronounced the closer to vertical is the ________.
A) IS curve
B) LM curve
D) aggregate demand function
Answer: B
Diff: 2 Type: MC
Skill: Recall
6) The less interest-sensitive is money demand, the ________.

A) more effective is fiscal policy relative to monetary policy
B) more effective is monetary policy relative to fiscal policy
C) steeper is the IS curve
D) flatter is the LM curve
Answer: B
Diff: 2 Type: MC
Skill: Recall
7) The more interest-sensitive is money demand, the ________.

D) steeper is the LM curve
Answer: A
Diff: 2 Type: MC
Skill: Recall
8) If the economy is characterized by a certain and stable LM curve, then ________ target
produces ________ fluctuations in aggregate output.
A) an interest rate; smaller
B) a money supply; smaller
C) a money supply; larger
D) an exchange rate; larger
Answer: B
Diff: 2 Type: MC
Skill: Recall
20
9) If the economy is characterized by a stable IS curve and an unstable LM curve, then
________ target produces ________ fluctuations in aggregate output.
A) an interest rate; larger
D) an exchange rate; smaller
Answer: C
Diff: 2 Type: MC
Skill: Recall
10) If the ________ curve is relatively more unstable than the ________ curve, a money supply
target is preferred.
A) IS; IS
B) IS; LM
C) LM; IS
D) LM; LM
Answer: B
Diff: 2 Type: MC
Skill: Recall
11) If the ________ curve is relatively more unstable than the ________ curve, an interest rate
A) IS; IS
B) IS; LM
C) LM; IS
D) LM; LM
Answer: C
Diff: 2 Type: MC
Skill: Recall
12) If the Fed adopts a policy of pegging the interest rate, a ________ in government spending
forces the Fed to increase the money supply to prevent interest rates from ________.
A) fall; increasing
B) fall; decreasing
C) rise; decreasing
D) rise; increasing
Answer: D
Diff: 3 Type: MC
Skill: Applied
21
13) Using the ISLM model, explain and show graphically the effect of a fiscal expansion when
the demand for money is completely insensitive to changes in the interest rate. What is this
effect called?
This is the total crowding out effect. The LM curve is vertical, so any shift of the IS curve
affects only interest rates. The level of output is constant. The fiscal expansion shifts the IS
curve rightward, increasing the interest rate.
Diff: 2 Type: ES
Skill: Recall
22
14) Show graphically and explain why targeting an interest rate is preferable when money
demand is unstable and the IS curve is stable.
Unstable money demand causes the LM curve to shift between LM' and LM". If the money
supply is targeted, output fluctuates between Y' and Y". With an interest rate target, output
remains stable at Y. Since the objective is to minimize output fluctuations, targeting the interest
rate is preferable.
Diff: 2 Type: ES
Skill: Applied
15) Crowding out will be more pronounced the closer to vertical is the ________.
A) IS curve
B) LM curve
D) aggregate demand function
Answer: B
Diff: 2 Type: MC
Skill: Recall
23
16) The less interest-sensitive is money demand, the ________.
D) flatter is the LM curve
Answer: B
Diff: 2 Type: MC
Skill: Recall
17) The more interest-sensitive is money demand, the ________.

D) steeper is the LM curve
Answer: A
Diff: 2 Type: MC
Skill: Recall
18) If the economy is characterized by a certain and stable LM curve, then ________ target
produces ________ fluctuations in aggregate output.
A) an interest rate; smaller
D) an exchange rate; larger
Answer: B
Diff: 2 Type: MC
Skill: Recall
19) If the economy is characterized by a stable IS curve and an unstable LM curve, then
________ target produces ________ fluctuations in aggregate output.
A) an interest rate; larger
D) an exchange rate; smaller
Answer: C
Diff: 2 Type: MC
Skill: Recall
24
20) If the ________ curve is relatively more unstable than the ________ curve, a money supply
A) IS; IS
B) IS; LM
C) LM; IS
D) LM; LM
Answer: B
Diff: 2 Type: MC
Skill: Recall
21) If the ________ curve is relatively more unstable than the ________ curve, an interest rate
A) IS; IS
B) IS; LM
C) LM; IS
D) LM; LM
Answer: C
Diff: 2 Type: MC
Skill: Recall
25
22) If the IS and LM curves in the economy are given by the curves in the following diagram,
what would lead to the particular LM curve depicted? How would this affect fiscal and
monetary policies?
Answer: The students must point that the LM curve in this diagram has the property of being
vertical to the output axis. This can be the case when money demand in the economy is
unaffected by the interest rate (it is interest-inelastic). In a special case like this fiscal policy is
completely ineffective in terms of affecting aggregate output while monetary policy is very
effective. This is the case of complete crowding out.
Diff: 3 Type: ES
Skill: Recall
23) When is the targeting of the money supply preferred to the interest-rate target? support your
answer with the appropriate diagram.
Answer: The students must draw the diagram (Figure 8 in the textbook) of the textbook where
they show diagramatically that a money supply target is preferred in terms of output
fluctuation, when the IS curve is more unstable than the LM curve is.
Diff: 3 Type: ES
Skill: Recall
24) When is an interest-rate target preferred to the targeting of the money supply? support your
answer with the appropriate diagram.
Answer: The students must draw the diagram from page 15 (Figure 9 in the textbook) of the
textbook where they show diagramatically that an interest rate target is preferred in terms of
output fluctuation, when the LM curve is more unstable than the IS curve is.
Diff: 3 Type: ES
Skill: Recall
26
28.6 ISLM in the Long Run
1) In the long-run ISLM model and with everything else held constant, an increase in the
money supply leaves the level of output and interest rates unchanged, an outcome called
________.
A) interest rate overshooting
B) long-run money neutrality
C) long-run crowding out
D) the long-run Phillips curve
Answer: B
Diff: 2 Type: MC
Skill: Recall
2) In the long-run ISLM model and with everything else held constant, the long-run effect of an
expansionary monetary policy is to ________.
A) increase real output and the interest rate
B) not change either real output or the real interest rate
C) increase real output and leave the interest rate unchanged
D) increase the interest rate and leave real output unchanged
Answer: B
Diff: 2 Type: MC
Skill: Recall
3) The long-run neutrality of money refers to the fact that in the long run, monetary policy
________.
A) changes only real output
B) changes only the real interest rate
C) changes both real output and the real interest rate
D) has no effect on either real output or the real interest rate
Answer: D
Diff: 2 Type: MC
Skill: Recall
expansionary fiscal policy is to ________ real output and ________ the interest rate.
B) not change; not change
C) increase; not change
D) not change; increase
Answer: D
Diff: 2 Type: MC
Skill: Recall
27
5) In the long-run ISLM model and with everything else held constant, the long-run effect of a
contractionary fiscal policy is to ________ real output and ________ the interest rate.
A) not change; not change
B) decrease; decrease
C) decrease; not change
D) not change; decrease
Answer: D
Diff: 2 Type: MC
Skill: Recall
cut in government spending is to ________ real output and ________ the interest rate.
B) increase; not change
C) not change; increase
Answer: D
Diff: 2 Type: MC
Skill: Recall
tax cut is to ________ real output and ________ the interest rate.
Answer: C
Diff: 2 Type: MC
Skill: Recall
autonomous increase in investment is to ________ real output and ________ the interest rate.
Answer: C
Diff: 2 Type: MC
Skill: Recall
28
fall in net exports is to ________ real output and ________ the interest rate.
Answer: D
Diff: 2 Type: MC
Skill: Recall
10) In the long-run ISLM model and with everything else held constant, the long-run effect of
an autonomous fall in consumption expenditure is to ________ real output and ________ the
interest rate.
Answer: D
Diff: 2 Type: MC
Skill: Recall
11) In the long-run the ISLM model predicts that ________ can change real output.
A) only monetary policy
B) only fiscal policy
C) both monetary and fiscal policy
D) neither monetary nor fiscal policy
Answer: D
Diff: 2 Type: MC
Skill: Recall
12) As long as the level of output ________ the natural rate level, the price level will continue
to ________, shifting the LM curve to the ________, until finally output is back at the natural
rate level.
A) exceeds; rise; right
B) exceeds; rise; left
C) remains below; fall; left
D) remains below; rise; right
Answer: B
Diff: 2 Type: MC
Skill: Recall
29
13) In the long-run ISLM model and with everything else held constant, as long as the level of
output ________ the natural rate level, the price level will continue to ________, shifting the
LM curve to the ________, until finally output is back at the natural rate level.
A) exceeds; rise; right
B) exceeds; fall; left
C) remains below; fall; right
D) remains below; rise; left
Answer: C
Diff: 2 Type: MC
Skill: Recall
14) Using the long-run ISLM model, explain and demonstrate graphically the neutrality of
money, for the case of an increase in the money supply.
The increase in the money supply shifts LM to the right, increasing output to Y', above the
natural rate Y*. The interest rate falls from i to i' . Excess demand increases the price level,
reducing the real value of the money supply. The LM curve shifts back until the all pressure on
prices is eliminated by the return to the natural rate of output. The initial and final levels of
output and interest rate are the same. No real variables have changed.
Diff: 3 Type: ES
Skill: Recall
30
15) Using the appropriate diagram, show that fiscal policy is ineffective in the long-run.
Answer:
In a diagram like the above students must show that if the natural rate level of output is Y1 and
the economy is in equilibrium at point 1, an increase in government spending will shift the IS1
curve to the left to IS2 and the economy will move to point 4 where the interest rate is higher
are i3 from i1 and the aggregate output is higher from Y1 to Y4. But since Y4 is above the
natural rate level of Y1 the price level begins to rise and real money balances M/P begin to fall
so that the LM curve will shift from LM1 to LM2. The long-run equilibrium is at point 2 where
the interest rate is i2 higher than i1 and aggregate output has returned to Y1.
Diff: 3 Type: ES
Skill: Recall
31
16) Show graphically and explain why targeting an interest rate is preferable when money
demand is unstable and the IS curve is stable.
Unstable money demand causes the LM curve to shift between LM' and LM". If the money
supply is targeted, output fluctuates between Y' and Y". With an interest rate target, output
remains stable at Y. Since the objective is to minimize output fluctuations, targeting the interest
rate is preferable.
Diff: 3 Type: ES
Skill: Recall
32

Mishkin 6ce TB Ch28

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Mishkin 6ce TB Ch28

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Economics of Money, Banking, and Financial Markets 6e (Mishkin)

Chapter 28 Web Chapter 2: The ISLM Model

28.1 Keynes's Fixed Price Level Assumption and the IS Curve

1) The key assumption in the ISLM model is that ________.

2) The money market is in equilibrium ________.

28.2 ISLM Approach to Aggregate Output and Interest Rates

1) Macroeconomic equilibrium requires ________.

9) The money market is in equilibrium ________.

1) The money market is in equilibrium ________.

1) In the ISLM framework, an expansionary monetary policy causes aggregate output to

5) Everything else held constant, a monetary contraction is characterized by ________ output

13) Despite an expansionary monetary policy, an economy experiences a recession. Everything

6) The less interest-sensitive is money demand, the ________.

7) The more interest-sensitive is money demand, the ________.

17) The more interest-sensitive is money demand, the ________.

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