CHAPTER 12
Equilibrium in the Financial System: LM Model
Introduction
Equilibrium in the goods market is necessary, but not sufficient for equilibrium in the overall economy. To achieve overall equilibrium in the economy, it is also necessary to have equilibrium in the money market.
Recall that Keynes demonstrated the link between interest rate and demand for money. We have also shown that during inflationary periods, the price level, that is, the prices of all the goods including money, increase. Because interest rate is the price of money, it is necessary to use the real interest rate in economic analysis instead of the nominal interest rate. Here, the word real is used in contrast to the word nominal. The nominal interest rate is equal to ...
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