Let the LM curve be subject to random shocks. As government spending becomes more positively) responsive to the gap between actual and potential GDP, the desirability of setting monetary policy to achieve
A) an interest rate target necessarily increases.
B) a GDP target necessarily increases.
C) an exchange rate target necessarily increases.
D) a money supply target necessarily increases.
E) an employment target necessarily increases.

Question

Quizplus · Accepted Answer

An interest rate target is necessary to stabilize the economy when the LM curve is subject to random shocks. This is because the interest rate is the primary tool that the central bank can use to influence the money supply and, thus, aggregate demand. By setting an interest rate target, the central bank can help to ensure that the economy remains close to its potential output level.

Let the LM Curve Be Subject to Random Shocks