Final equilibrium: r
1
, Y
1
Conclusion:
MS
r
and Y
.
MS
Y (but only a smaller increase in Y)
Monetary policy is
less effective
(has a small effect on Y)
when money demand is interest-elastic.
Since the MD is interest elastic, a small drop in
interest rate is required to reequilibrate the money
market after the increase in the money stock. As a
consequence, I & Y increase by a smaller amount.

Monetary Policy Effectiveness &
the Slope of the LM Curve
(c) Completely interest-inelastic money demand
r
1
LM
0
IS
0
LM
1
E’
E
r
Y
0
Y
1
Y
r
0
Suppose that MS
(expansionary MP) while P unchanged.
MS
LM curve shifts rightward.
r
(from r
0
to r
1
)
Y
(from Y
0
to Y
1
).
Final equilibrium: r
1
, Y
1
Conclusion:
MS
r
and Y
.
MS
Y (a largest increase in Y)
Monetary policy is
most effective
(has a largest effect
on Y) when money demand is completely interest-
inelastic.
Since the MD is interest inelastic, a large drop in interest
rate is required to reequilibrate the money market after
the increase in the money stock. However, MD is not
affected by r. The only way to reequilibrate the money
market
is to increase Y to Y
1
.

Monetary Policy Effectiveness &
the Slope of the LM Curve
(d) Completely interest-elastic money demand
LM
0
IS
0
= LM
1
E
r
Y
0
= Y
1
Y
r
0
Suppose that MS
(expansionary MP) while P unchanged.
MS
LM curve shifts rightward (from LM
0
to LM
1
).
Final equilibrium: r
0
, Y
0
Conclusion:
MS
Y unchanged
Conclusion:
MS
Y unchanged
Monetary policy is
most ineffective
(has no effect on Y)
when money demand is completely interest-elastic.
Since the MD is completely interest elastic, an
increase in the MS does not change the r (i.e.
liquidity trap). As a consequence, I & Y will remain
unchanged.

Fiscal Policy Effectiveness & the
Slope of the LM Curve
(a) Interest-elastic money demand
r
1
LM
IS
0
IS
1
E’
E
r
Y
0
Y
1
Y
r
0
Suppose that G
(expansionary FP)
G
IS curve shift to the right (from IS
0
to IS
1
)
Y
(from Y
0
to Y
1
)
r
(from r
0
to r
1
)
Final equilibrium: r
1
, Y
1
Conclusion:
G
Y
Fiscal policy is effective (has a larger effect on Y) when money demand is interest-elastic.Since the MD is interest elastic, only a small rise in interest rate is required to reequilibrate the money market given the unchanged money stock. As a consequence, I & Y decline by a smaller amount (i.e. smaller C-O effect).Y
2
D

Fiscal Policy Effectiveness & the
Slope of the LM Curve
(b) Interest-inelastic money demand
r
1
LM
IS
0
IS
1
E’
E
r
Y
0
Y
1
Y
r
0
Suppose that G
(expansionary FP)
G
IS curve shift to the right (from IS
0
to IS
1
)
Y
(from Y
0
to Y
1
)
r
(from r
0
to r
1
)
Final equilibrium: r
1
, Y
1
Conclusion:
G
Y
Fiscal policy is less effective (has a smaller effect on Y) when money demand is interest-inelastic.Since the MD is interest inelastic, a greater rise in interest rate is required to reequilibrate the money market given the unchanged money stock. As a consequence, I & Y decline by a greater amount (greater C-O effect). Y
2
D