Economic Help Please...Why does high interest rates shift the LM curve to the right
Thanks...
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LM is the money-supply curve in the model. High interest rates are a consequence of shifting the curve upward.
It doesn't shift upward...it shifts to the right
when interest rates are high people invest more instead of holding the money or money is spent rapidly
Depends on what else is going on in the model
If there is some exogenous change in interest rates (for example, if you're looking at a small open economy and savings decreasing in the global market for loanable funds), then borrowing in your country becomes more expensive and investment falls, reducing output (y).
In the market for real balances, the liquidity demand curve, L, is a function of output (y) and interest rates (r). Because their is less output, fewer transactions are occurring and thus less liquidity is demanded; and because interest rates are higher, there is less demand for liquidity/real balances (because the demand is now for deposits that receive the higher interest rate). Both affects shift the L curve to the left for a give money supply, reducing interest rates to some equilibrium in the market for real balances that would manifest itself in the IS-LM model as a rightward shift in the LM curve, bring y back to the potential output level.
This is because for a central bank to increase interest rates it needs to increase the money supply. It does so by selling government debt at a discount, lowering the prices of similar government debt across the debt markets and, of course when bond prices go down, yield (interest rates) go UP.
This raises equilibrium national income since savings are now returning a higher level of income.This is my understanding at least, sorry if I missed anything.
He Eisner, increasing the money supply lowers interest rates. The central bank doesn't sell debt at a discount. It sells bonds to banks crediting their reserve accounts forcing them to lower rates/create loans.
Sorry... #economics fail
I will now slink back into Econ 101
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