g the central bank pursues real interest targeting, in a graph with the real interest rate on the vertical axis and national income on the horizontal axis, a reduction in the risk premium can be represented as:Question 3Answera.A rightward shift of the IS curveb.An upward shift of the LM curve c.A downward shift of the LM curve d.A movement along the IS curve
Question
g the central bank pursues real interest targeting, in a graph with the real interest rate on the vertical axis and national income on the horizontal axis, a reduction in the risk premium can be represented as:Question 3Answera.A rightward shift of the IS curveb.An upward shift of the LM curve c.A downward shift of the LM curve d.A movement along the IS curve
Solution
The answer is c. A downward shift of the LM curve.
Here's why:
The LM curve represents the relationship between the real interest rate and the level of income that arises from the equilibrium in the money market.
When the central bank pursues real interest targeting, it adjusts the money supply to keep the real interest rate at its target level.
A reduction in the risk premium reduces the demand for money at any given level of income and real interest rate. This is because with a lower risk premium, people are more willing to hold wealth in forms other than money.
To keep the real interest rate at its target level, the central bank must increase the money supply. This shifts the LM curve downward.
So, a reduction in the risk premium, when the central bank is pursuing real interest targeting, can be represented as a downward shift of the LM curve.
Similar Questions
TipsQuestion textAssuming the central bank pursues real interest targeting, in a graph with the real interest rate on the vertical axis and national income on the horizontal axis, a reduction in the expected rate of inflation can be represented as:Question 2Answera.A movement along the IS curveA commercial bank purchases treasury bonds during the opening hours of the stock marketb.An upward shift of the LM curvec.A downward shift of the LM curve d.A rightward shift of the IS curve
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