Demand management policies

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Question

Monetary and fiscal policies are also called demand management policies because they influence the level of aggregate demand (Y) in the economy. Using IS-LM diagrams, answer the following questions.

1. Suppose the central bank tightens monetary policy to reduce aggregate demand. What happens to aggregate demand and the interest rate if the government responds by tightening fiscal policy? What happens when the government loosens fiscal policy instead?

2. Explain the transmission mechanism of monetary policy on aggregate demand in words. In light of your explanation, why does monetary policy become weaker when money demand becomes more sensitive to the interest rate?

Reference no: EM133985888

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