If the interest rate stayed constant at i1, the goods market is in equilibrium in that planned spending equals output, but the assets market is no longer in equilibrium. Income has increased, and, therefore, the quantity of money demanded is higher. Because there is an excessive demand for real balances, the interest rate rises. Firms planned spending declines at higher interest rates, thus the aggregate demand falls. Therefore, the equilibrium is at higher interest rates. The adjustment of interest rates and their impact on aggregate demand dampen the expansionary effect of the increased government spending.
The IS curve moves to the right, causing higher interest rates (i) and expansion in the "real" economy (real GDP, or Y).
Crowding out (economics) little effect on the equilibrium output. So, if the LM curve is horizontal, monetary policy has no impact on the equilibrium of the economy and the fiscal policy has a maximal effect.
References
Roger W. Spencer & William P. Yohe, 1970. The 'Crowding Out' of Private Expenditures by Fiscal Policy Actions, Federal Reserve Bank of St. Louis Review, October, pp. 12-24 (http:/ / research. stlouisfed. org/ publications/review/70/10/Expenditures_Oct1970.pdf)
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