A change in which of the following would cause the LM curve to shift? To rotate? To both
shift and rotate? Which do not affect the position or slope of the LM curve?
The LM curve in the IS-LM model represents equilibrium in the money market, where the demand for money (MD) equals the supply of money (MS). The LM curve illustrates the relationship between interest rates and real GDP that maintains money market equilibrium. Various factors can influence the position and slope of the LM curve. This article will explore which changes cause the LM curve to shift, rotate, both shift and rotate, and which do not affect its position or slope.
Factors Causing the LM Curve to Shift
(a) Nominal Money Supply → Shift
The nominal money supply directly affects the LM curve. An increase in the nominal money supply shifts the LM curve to the right, indicating lower interest rates for a given level of income, as there is more money available. Conversely, a decrease in the money supply shifts the LM curve to the left.
Factors Causing the LM Curve to Rotate
(b) Sensitivity of MD to the Interest Rate → Rotate
The sensitivity of money demand (MD) to the interest rate affects the slope of the LM curve. If money demand becomes more sensitive to interest rates (higher elasticity), the LM curve becomes flatter. If money demand becomes less sensitive to interest rates (lower elasticity), the LM curve becomes steeper. Changes in this sensitivity do not shift the curve but change its slope.
(c) Sensitivity of MD to Income → Rotate
The sensitivity of money demand to income also influences the slope of the LM curve. If money demand becomes more sensitive to income (higher elasticity), the LM curve becomes steeper, as higher income levels lead to a larger increase in interest rates. If money demand becomes less sensitive to income (lower elasticity), the LM curve becomes flatter.
(h) Switch from Checks to Credit Cards → Rotate
Switching from checks to credit cards affects the velocity of money circulation and can influence the sensitivity of money demand to income and interest rates. If this switch makes money demand less sensitive to interest rate changes, the LM curve would rotate, becoming flatter or steeper depending on the exact effect on money demand elasticity.
Factors Causing Both Shift and Rotate of the LM Curve
(b) Sensitivity of MD to the Interest Rate → Rotate, Shift
While the primary effect of a change in the sensitivity of money demand to the interest rate is to rotate the LM curve, it can also cause a shift if the change in sensitivity is accompanied by a change in the nominal money supply or other monetary conditions. For example, if increased sensitivity also involves a central bank policy adjustment, the LM curve may shift as well as rotate.
Factors That Do Not Affect the Position or Slope of the LM Curve
(d) Business & Consumer Confidence → No Effect
Changes in business and consumer confidence primarily affect the IS curve (investment-saving equilibrium) as they influence spending and investment behaviors. They do not directly impact the money market equilibrium, hence no effect on the LM curve.
(e) Interest Rate → No Effect
The interest rate itself is a variable on the LM curve, not a factor that shifts or rotates it. Changes in interest rates represent movements along the LM curve rather than changes in its position or slope.
(f) In 2001, EU Countries Switched from Own Currencies to Euro → No Effect
This change primarily affects the foreign exchange market and the overall monetary policy environment but does not directly impact the position or slope of the LM curve within an individual country’s money market framework.
(g) Switch from Checks to Debit Cards → No Effect
Switching from checks to debit cards might change transaction mechanisms but does not significantly affect the overall demand for money in a way that would shift or rotate the LM curve. It is more about the method of accessing money rather than changing money demand or supply dynamics.
Conclusion
Understanding the factors that affect the LM curve is crucial for analyzing monetary policy and its impact on the economy. Changes in the nominal money supply shift the LM curve, while changes in the sensitivity of money demand to interest rates and income rotate the curve. Some changes, like the switch from checks to credit cards, can both rotate and shift the LM curve depending on broader monetary conditions. However, factors such as business and consumer confidence, the interest rate itself, the switch to the euro, and the use of debit cards do not impact the LM curve’s position or slope. Recognizing these distinctions helps in comprehensively understanding the dynamics of money market equilibrium.