expected inflation rate dse 2011

[aditi5000]

question 17
if expected inflation rate rises, what happens to LM
1. shifts up
2. down
3. unchanged
4. ambiguous

if we look at LM as M/P then answer must be option 2 but if we look at LM as simply M then answer will be 3. so in the exam how do we know what is being talked off? in most islm questions we are provided M/P and not M but doesn't mean that LM with simply M is wrong!! someone please help... Amit Sir.... Please clarify.

[Amit Goyal]

If we plot LM curve is (Y, i) space, it will remain unaffected.

[aditi5000]

Yes Sir thats the problem I'm facing.. when plotted in Y, nominal i then it is unchanged but when plotted with Y, real i then it shifts the LM down and right so what space are they talking about? is LM usually interpreted with real or nominal interest rate? I have come across both in 2 different books

[ritu]

my undergrad text tells that for lm relevent rate is nominal and for is its real roi...so in this case when u plot is lm in nominal i,y space ur is will shify nd lm is unchanged...

[aditi5000]

Okkk!! Thanks Ritu :) And in which direction does IS shift...

[ritu]

i=r +exp infln
so for given i if exp infln rises ,r shud fall so is will shift right in nominal i ,y space

[Amit Goyal]

I know if you plot it in (Y, r) space it shifts. But since nothing is mentioned about the space in the question, we need to assume the space of reference. I assumed (Y, i) because money demand is a function of Y and i.

[aditi5000]

Yes Sir you are right, that makes sense. your assumption is rational whereas mine is whimsical :P thank you so much!!!!

[aditi5000]

Thank you Ritu!!! you have no idea what you have done for me today :) :) thank you so much!!!

[ritu]

aditi dont say thanx:-)
a big big thanx to amit sir...:-):-)

[Amit Goyal]

Equally Big Welcome from me too :-)

[lovekesh]

@aditi, ritu
so i can conclude that if it's not mentioned why is people expecting inflation, and since IS curve shifts out because of increased investment, then expected inflation is good for economy? And i don't get the economic reason behind expected inflation shifting IS curve . Or IS curve shifts coz of increased savings, if that is so, then consumption has also reduced.

[Chinni18]

Generally when unemployment is lower than the natural rate of unemployment, then there's overcapacity in the economy and hence prices are expected to increase.
If it mentioned that Marshall-lerner condtn is satisfied then LM would shift in (Y,i) space because it will be real interest rate that we are looking at, otherwise no shift, only IS shifts

[Rain Man]

@Chinni18

It would be great if you can support the explanation ( increase in expected inflation ) using the IS-LM Equations .
And please give some more info. on the Marshall-Lenner condition and the role it is playing here.

Thank you very very much..!!

[Ayushya Kaul]

One question sir, why wont nominal interest rate increase when inflation increases?