During the financial crisis of 2008-2009, many financial institutions stopped making loans even to creditworthy customers, which could be represented in the IS-LM model as a(n):
A) expansionary shift in the IS curve.
B) contractionary shift in the IS curve.
C) expansionary shift in the LM curve.
D) contractionary shift in the LM curve.

Question

Quizplus · Accepted Answer

This scenario is represented as a contractionary shift in the IS curve because the IS curve represents the relationship between interest rates and the level of income that is in equilibrium in the goods market. When financial institutions stop making loans, investment decreases, leading to a decrease in aggregate demand and a leftward (contractionary) shift in the IS curve.

During the Financial Crisis of 2008-2009, Many Financial Institutions Stopped