Unconventional monetary policy: financial policy and quantitative easing The IS curve represents the equilibrium in the goods market and the LM curve represents the equilibrium in the money market. As mentioned in the text, the following are the equations for the IS-LM curve:

\[
\begin{equation*}
\text { IS relation: } \quad Y=C(Y-T)+I(Y, r+x)+G \tag{6.5}
\end{equation*}
\]

LM relation: \(r=\bar{r}\)

LM relation: \(r=\bar{r}\)

Where the interest rate is the policy interest rate adjusted for expected inflation. Assume that the rate at which firms can borrow is much higher than the policy interest rate, hence the premium, \(x\), in the IS equation is high.

a. After the global financial crisis several European economies adopted quantitative easing, better known as QE. Quantitative easing is an expansionary monetary policy used by the central bank, to buy financial assets from distressed commercial banks and large private institutions to facilitate the flow of credit in the financial markets. If QE proves to be successful, interest rates would decline, hence inducing increased investment and higher output. What is the effect on the IS-LM model?

b. Most emerging market economies did not have to resort to quantitative easing since their policy interest rates were quite high allowing for consecutive expansion of money supply and subsequent lower interest rates. However, it was the advanced economies with their interest rates approaching the zero level that were obliged to use this unconventional tool of monetary policy. Explain why QE was an imperative tool during the uncertainty and the low interest rates that prevailed during the global financial crisis.

c. One reason that quantitative easing was not successful is that it did not meet the outlook for higher expected inflation. What other reasons could explain why QE has not proved very effective?