According to the IS-LM model, in a liquidity trap a decrease in public spending causes the GDP to:
A)increase.
B)decline.
C)remain constant.
D)fluctuate.

Question

Quizplus · Accepted Answer

In a liquidity trap, monetary policy is ineffective, and the interest rate is already very low, so the LM curve is flat. Also, the economy operates below its potential output level due to decreased investment demand. As a result, a decrease in public spending shifts the IS curve to the left, reducing both GDP and the interest rate. However, since the LM curve is flat, the decrease in the interest rate has no impact on investment demand. Therefore, the decline in public spending leads to a decline in GDP.

According to the IS-LM Model, in a Liquidity Trap a Decrease