Short-run Fluctuations in an Open EconomyV tutees - Balance...

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Short-run Fluctuations in
an Open Economy
Tutional BBA
International Economics.
P’ O
Tuitional BBA
International Economics
Contact no. 089-136-3264
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Balance of Payment.
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The BP Curve
• BP curve – a curve that represents combinations of interest rates
and income levels at a given exchange rate at which the Balance of
payment is in equilibrium.
CA deficit/surplus
CA
Y
Y l Î e constant Î Im l Î CA ……….
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KA
i
KA deficit/surplus
r l Î Cap …… Î KA ………
i
Y
BP Curve
Y
0
r
w

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• If income increases, the CA will be in deficit.
• To keep the BP in equilibrium, the interest rate must rise enough to
bring the KA into surplus to offset.
• A rise in income requires a rise in interest rate. A decline in income
require a decline in interest rates.
i
Y
BP Curve
Surplus
zone
Deficit
Zone
A
At point A, the BP is in surplus b/c, the interest is higher than the interest rate that is
Consistent with a BP of equilibrium.
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• The slope of the BP curve. Î Depends on 2 factors.
1. The responsiveness of capital flows to interest.
2. The responsiveness of imports to income. Î MPM
•As cap flows become
more responsive to diff
between domestic and
world i. Î BP flatter.
•As import become more
responsive to change in
income (MPM increase)
Î BP steeper.
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Policies that shift the BP curve
1. Exchange rates policies.
– change e Î BP shift to new equilibrium
BP
0
A
• Initially, at A, BP = 0.
• e Depre Î X l & Im l Î at A BP surplus
• To equilibrium, Y l or i l
• If i l Î Move to point B
• If Y l Î Move to point C
• The BP
1
represents all combinations of
Y and i at which BP = 0.
• Depre Î BP shift ………..
• Appre Î BP shift …………….
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Policies that shift the BP curve
2. Import control and Export Drives.