As the government spending increases, the aggregate expenditure increases. This results in the increase in income.

Now in the money market as the income increases, transaction demand for money increases. This leads to increases in aggregate demand for money. Since the supply is fixed, usually the speculative demand decreases (due to increase in interest rate) to re-equilibrate the money market. But since the LM schedule is vertical (perfectly inelastic) that can’t happen. Then how does the interest rate increase in this case?


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