SolutiontopastexamC - PartC 9 Note that since the slope of...

Info icon This preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: PartC 9 Note that since the slope of the BP curve is not specified, you can use any one that you want. Here we will use a BP curve which has a smaller slope than the LM curve. The initial equilibrium at “a” is the intersection of LMO, ISO, and BPo. See diagram below. See diagram below. The temporary equilibrium at “b” is the intersection of LMl with ISO. Domestic interest rate is lower at the temporary equilibrium. When the domestic central bank expands money supply, there is excess supply of money initially. Domestic interest rate falls so that the opportunity cost of holding money decreases. This will then cause an increase in demand for money, and equilibrium in the money market is maintained. Domestic income is higher at the temporary equilibrium. When domestic interest rate falls, the cost of borrowing also falls. This encourages domestic investment, which is a component of total expenditure, and expands output. There is a temporary BOP deficit. The lower domestic interest rate causes a capital outflow, which results in a deterioration of the capital account. The higher domestic income/output causes consumption to increase, including imported goods and services. The increase in induced imports results in a deterioration of the current account. Both factors will lead to a BOP deficit. The BOP deficit causes a domestic currency depreciation. This will cause both the BP and IS curves to shifi to the right. The depreciation of the domestic currency causes autonomous exports to increase and autonomous imports to decrease as domestic goods and services become relatively more competitive, compared with foreign goods and services. This, in turn, will increase domestic income/output. The final equilibrium is at point “c”, where LM‘, [8,, and BPI intersect. Here are some of the main points. Pros: a. lmposes monetary discipline. The domestic central bank cannot pursue an inflationary policy with monetary policy. b. Eliminate exchange rate risk (uncertainty). This will promote international trade and economic growth. c. Prevents the wastefiil constant movements in and out of the tradable goods sectors of the economy by factors of production. Cons: a. Loss of monetary autonomy. This can potentially cause a conflict between internal and external balances. b. Can lead to destabilizing speculation against the domestic currency 0. Disturbances from foreign countries are transmitted to the domestic economy. There is no protection against foreign disturbances. ...
View Full Document

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern