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Problem Set 8 – Some Answers FE312 Fall 2010 Rahman

FE312 Fall 2010 Rahman Page 3 of 8 Since the level of output is now above its long-run level, prices begin to rise. A rising price level lowers real balances, which raises the interest rate. As indicated in the figure, the LM curve shifts back to the left. Prices continue to rise until the economy returns to its original position at point A.

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