1. the LM curve has no role in determining the level of domestic output.
2. shifts in the IS curve eventually lead to changes in the nominal money stock.
3. the stock of high-powered money is endogenous.
4. all of the above are true.
Choose the correct option.
The right choice is option 4. Equilibrium is determined by the intersection of IS and ZZ. Under conditions of less than full employment with P fixed these curves determine Y which, together with the internationally determined real interest rate and the expected rate of inflation, determine the quantity of money demanded. If the supply of money does not equal this quantity, domestic residents will achieve portfolio equilibrium by adjusting their holdings of non-monetary assets by purchasing or selling them abroad. The authorities, to maintain the fixed exchange rate, are forced to finance this portfolio shift by exchanging domestic money and foreign exchange reserves, thereby moving the stock of base money to an appropriate level. Domestic base money is thus endogenous and the money supply is independent of the actions of the authorities. Shifts in IS will cause an equal shift of LM by changing equilibrium output and inducing changes in the money supply.
The IS curve can shift as a result of exogenous changes in desired consumption, investment and net exports, or from changes in the level at which the government is fixing Π. This will cause income to change and with it the quantity of money demanded. A portfolio adjustment will then lead to pressure on the exchange rate and the authorities, in order to keep the rate fixed, are forced to adjust the money supply to equal the demand. This will shift the LM curve until it crosses ZZ at the same point as IS.