One common modification of the IS-LM model given by the equilibrium condition XXXXXXXXXXis to include a so-called real-balance effect in the consumption and savings functions. According to the...

One common modification of the IS-LM model given by the equilibrium condition (3.23) is to include a so-called real-balance effect in the consumption and savings functions. According to the real-balance effect, real balances m = Ms I p directly influence both consumption and savings. In particular, an increase in real balances will increase consumption and decrease savings. Thus with the real-balance effect included, the savings function in should be written as

where S_y
and S_r
are defined as before but
Assuming that the other functions in the IS-LM model given in the text remain the same, answer the following questions regarding the IS-LM model with a real-balance effect included.

(a) Find the impact of an expansionary monetary policy on Y* and r* (i.e., fin

(b) Can the expressions derived in (a) be signed from the sign restrictions of the model? If so, what are the signs?

(c) Draw an IS-LM diagram to demonstrate the results in (b).