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Q. Money market with inflation and constant money supply growth?
If πM = π and πe = π, both IS- and LM-curve will be fixed.
Figure: The money market with inflation and constant money supply growth
It is then likely to determine R* and Y *. We can also figure out the real interest rate as r = R - πe and πe is given. All variables are now concluded. As π and πW are exogenous, P and W are given over time (as long as we know W and P at one point in time). L is determined and we do not allow L to exceed LOPT as this would require a drop in real wages π > πW at least for a while.
If, for instance πM< π, LM curve will glide upwards, R (and r) will increase whereas Y will fall. In a model with inflation, we characteristically consider changes in the growth of money supply, πM, instead of changes in the money supply itself when we discuss monetary policy.
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