Allowing banks to pay interest on their checking account deposits should cause A) the LM curve to get flatter because larger increases in GDP could be accommodated by the same adjustment in real rates. B) the LM curve to get steeper because currency demand still is correlated with the real interest rate. C) ^{the LM curve to get steeper because}^{demand for}^M1 ^{becomes less} sensitive to changes in interest rates when rates paid on checking deposits parallel those paid by other financial assets. D) ^{the LM curve to become vertical because demand for}^M1 ^becomes totally independent of the interest rate. E) none of the above.

Question

Quizplus · Accepted Answer

Allowing banks to pay interest on checking account deposits makes holding money more attractive relative to other assets, as the opportunity cost of holding money decreases. This means that people are less likely to move their money out of checking accounts as interest rates change, making the demand for money less sensitive to interest rates. This in turn makes the LM curve steeper because a given change in the interest rate will have a smaller effect on the quantity of money demanded.

Allowing Banks to Pay Interest on Their Checking Account Deposits