According to the IS-LM model, if Congress raises taxes but the Fed wants to hold the interest rate constant, then the Fed must ______ the money supply.
A) increase
B) decrease
C) first increase and then decrease
D) first decrease and then increase

Question

Quizplus · Accepted Answer

If Congress raises taxes, there will be a decrease in disposable income, consumption, and investment, which shifts the IS curve to the left. If the Fed does not want the interest rate to change, it must offset the leftward shift of the IS curve by increasing the money supply, which shifts the LM curve to the right. The net effect is a decrease in output and no change in interest rate. Therefore, the Fed must decrease the money supply.

According to the IS-LM Model, If Congress Raises Taxes but the Fed