Macroeconomics 5th Edition by Olivier Blanchard

Exercise 8

You learned in problem 6 (on the liquidity trap) in Chapter 5 that money demand becomes very flat at low interest rates. For this problem, consider the money demand Junction to be horizontal at a zero nominal interest rate.
a. Draw the LM curve. How does the slope of the curve change when the interest rate rises above zero b. Draw the IS curve. Does the shape of the curve change (necessarily) when the interest rate falls below zero
c. Draw the AD curve (Hint: From the IS-LM diagram, think about the price level at which the interest rate is zero. How does the AD curve look above this price level How does the AD curve look below this price level )
d. Draw the AD and AS curves and assume that equilibrium is at a point where output is below the natural level of output and where the interest rate is zero. Suppose the central bank increases the money supply. What will be the effects on output in the short run and in the medium run Explain in words.