Which macroeconomic model demonstrates that an increase in government expenditure can lead to an equivalent or greater reduction in private investment, depending on the monetary policy regime?

💡 Solution & Explanation

The IS-LM model illustrates the general equilibrium of goods and money markets, showing that expansionary fiscal policy shifts the IS curve rightward, raising national income and interest rates. Higher interest rates increase the cost of borrowing, which can crowd out private investment depending on the monetary regime and money demand sensitivity. Alternative choices like the Solow-Swan model deal with long-run economic growth rather than short-run monetary and fiscal policy interactions. This framework was introduced by John Hicks and Alvin Hansen.