Answer to Question #155048 in Macroeconomics for Suga

Question

Economy is facing inflation. By using the IS-LM model, show that the inflation can be overcome by implementing contractionary monetary policy. Is it possible? Prove it

Answer 1

An increase in money leads to an increase in the supply of money. This leads to lower rates and an increase in demand in the short term. This will lead to demand inflation and higher prices. Which in the long term will lead to an increase in interest rates without changing real GDP.

Restraining monetary policy reduces the amount of money by returning the money supply to its previous state.