Economics 100B - 24 (4-12-2007)

Economics 100B - 24 (4-12-2007) - Economics 100B Professor...

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Economics 100B Professor Steven Wood 4/12/07 Lecture 24 ASUC Lecture Notes Online (formerly Black Lightning) is the only authorized note-taking service at UC Berkeley. Please do not share, copy or illegally distribute these notes. Our non-profit, student-run program depends on your individual subscription for its continued existence. These notes are copyrighted by the University of California and are for your personal use only. LECTURE Last time we discussed small open economies with perfect capital mobility. Today we are going to examine a more general scenario with partial capital mobility and go through the same scenarios. The IS-LM-BP Model The IS-LM curves establish internal equilibrium while the BP curve establishes external equilibrium. Both of these together are referred to as joint equilibrium. When we are not in joint equilibrium, we will have either a currency depreciation, appreciation, or the central bank will intervene in order to keep the currency stable. Partial Capital Mobility Partial capital mobility exists when the BP curve is upward sloping. There are two cases: 1) Partial capital mobility implies the BP line is flatter than the LM curve. We will examine these cases today and are most applicable to the real world. 2) Partial capital immobility implies the BP line is steeper than the LM curve. Policy Analysis with Partial Capital Mobility Let’s assume expansionary fiscal policy with fixed exchange rates : 1) IS Shifts out, income increases, and interest rates increase. 2) Higher interest rates create foreign capital inflows. a. Balance of payments surplus b. Demand for the currency exceeds supply. c. Currency wants to appreciate 3) Central bank must intervene in the foreign exchange market a. Central bank buys excess foreign currency b. Central bank sells domestic currency. This implies an increase in the money supply. 4) LM Curve now shifts to the right. Income rises and interest rates come down.
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ASUC Lecture Notes Online Economics 100B 04/12/07 The net result of this policy is higher income with higher interest rates. Expansionary fiscal policy is still very
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Economics 100B - 24 (4-12-2007) - Economics 100B Professor...

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