In the IS-MP model, if the policy interest rate increases, then in equilibrium:
A)output increases
B)consumption decreases.
C)investment rises.
D)all of the above.

Question

Quizplus · Accepted Answer

According to the IS-MP model, an increase in the policy interest rate leads to a decrease in investment and consumption, which in turn reduces aggregate demand and output. Therefore, option A is incorrect. However, the increase in the interest rate may lead to an inflow of foreign capital seeking higher returns, which may cause an appreciation of the currency and a decrease in net exports, thus reducing output further. Therefore, option C is also incorrect. Hence, the correct answer is B, as consumption decreases due to the higher interest rates.

In the IS-MP Model, If the Policy Interest Rate Increases