Homework Assignment 5
ECON 2020: Intermediate Macroeconomic Theory
Problem 1: (20 points)
“Monetary Policy is more effective when the LM curve is relatively steep.”
1. State whether the above statement is “True” or “False”. (2 points)
2. Explain your answer by graphing the IS-LM model in an extreme case which can demonstrate if
this statement is true or false. Use your graph to show how a monetary policy can affect the
market in this extreme case, explain. What is the name of this theory in regards of monetary
policy?
(18 points)
Problem 2: (20 points)
“Fiscal Policy is more effective when the LM curve is relatively flat.”
1. State whether the above statement is “True” or “False”. (2 points)
2. Explain your answer by graphing the IS-LM model in an extreme case which can demonstrate if
this statement is true or false. Use your graph to show how a fiscal policy can affect the market in
this extreme case, explain. What is the name of this theory in regards of monetary policy?
(18 points)
Problem 3: (25 points)
1. Explain how a decrease in tax rates in order to increase the aggregate demand and as a result a
higher level of GDP can have a crowding out effect. (5 points)
2. Use the IS-LM model as well as the AD-AS model to explain the crowding out effect graphically.
In your AD-AS model include both the very short-run AS and the positively sloped AS curves to
differentiate between the resulted output levels. Use the same output level labels in both models
to relate your two models to each other and get full credit. (20 points)
Problem 4: (15 points)
1. Assume that the economy is in a liquidity trap. Is there a crowding out effect for an expansionary
fiscal policy in this case? Explain. (5 points)
2. Use the IS-LM model to explain your answer graphically. (10 points)
Problem 5: (20 points)
1. Assume the central bank accommodates a fiscal expansion by increasing the money supply
enough to keep the interest rate at its current level. When the central bank accommodates a fiscal
expansion, we also say that they are monetizing the budget deficit: it uses some of the money it
has taken out of circulation to buy the bonds that the federal government uses to finance its
deficit. Can the central bank help to eliminate the crowding out effect of fiscal policy in this case?
Explain. (5 points)
2. Use the IS-LM model to explain your answer graphically. (15 points)
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