As consumption becomes more sensitive to the real rate of interest,
A) the IS curve gets steeper and monetary policy grows more effective in manipulating GDP in the short run.
B) the IS curve gets flatter and monetary policy grows more effective in manipulating GDP in the long run.
C) the IS curve gets flatter and monetary policy grows more effective in manipulating GDP in the short run.
D) the IS curve is unaffe c t e d, but monetary policy grows we a ker nonetheless.
E) the IS curve gets steeper and monetary policy grows less effective in manipulating GDP in the long run.

Question

Quizplus · Accepted Answer

When consumption becomes more sensitive to the real rate of interest, the IS curve, which represents the relationship between the interest rate and the level of income that brings the goods market into equilibrium, gets flatter. This is because a given change in the interest rate will have a larger effect on investment and hence on aggregate demand and GDP. Consequently, monetary policy, which operates largely through influencing interest rates, becomes more effective in manipulating GDP in the short run, as smaller changes in interest rates are required to achieve a given change in GDP.

As Consumption Becomes More Sensitive to the Real Rate of Interest