Allowing checking deposits to earn interest should not make the LM curve vertical because
A) the demand for checking deposits remains insensitive to changes in the interest rate.
B) the demand for currency remains sensitive to changes in the interest rate.
C) the rates paid to checking deposits usually move up when the returns paid to other assets moved down and vice versa.
D) banks do not immediately pay interest on checking accounts and depositors' reacting to the expectation of future earnings on checking deposits neutralize any potential stimulus.
E) none of the above.

Question

Quizplus · Accepted Answer

The LM curve represents the relationship between the liquidity preference (demand for money) and the money supply in an economy, with interest rates on one axis and the quantity of money on the other. If the demand for currency remains sensitive to changes in the interest rates, it means that as interest rates change, people will adjust their holdings of currency versus deposits, which affects the overall liquidity preference and money supply. This sensitivity ensures that the LM curve will not become vertical just because checking deposits earn interest, as the overall demand for money (including currency and deposits) still responds to changes in interest rates.

Allowing Checking Deposits to Earn Interest Should Not Make the LM