If the LM curve were vertical, then an increase in government spending or a reduction in taxes would
A) do nothing but increase GDP and leave interest rates fixed.
B) do nothing but increase interest rates, so that the resulting reduction in investment would exactly cancel the stimulative effects of either fiscal policy.
C) increase interest rates a bit but still generate some small increase in GDP.
D) stimulate growth in GDP only if it were accompanied by an increase in the money supply.
E) none of the above.

Question

Quizplus · Accepted Answer

When the LM curve is vertical, it implies that the money market is insensitive to changes in interest rates, meaning the demand for money is perfectly inelastic with respect to interest rates. In this scenario, an increase in government spending or a reduction in taxes would lead to higher interest rates as the government competes for a fixed supply of loanable funds. The higher interest rates would crowd out private investment, negating the stimulative effects of the fiscal policy on GDP.

If the LM Curve Were Vertical, Then an Increase in Government