Unformatted text preview: ISLMBP analysis: fixed exchange rates Fixed exchange rates:
Fixed
The BP curve ISLMBP analysis: fixed exchange rates
r r1 BP SURPLUS
DEFICIT O Y Zero Capital Flows ISLMBP analysis: fixed exchange rates
r BP
r1 SURPLUS
DEFICIT O Y Restricted Capital Flows ISLMBP analysis: fixed exchange rates
r SURPLUS BP DEFICIT O Y1 Restricted Capital Flows Y ISLMBP analysis: fixed exchange rates
r SURPLUS BP r1 DEFICIT O Y Unrestricted Capital Flows ISLMBP analysis: fixed exchange rates
r BP r1 a O Y1 Y ISLMBP analysis: fixed exchange rates
r
Assume that national
income rises BP r1 a O Y1 Y2 Y ISLMBP analysis: fixed exchange rates
r
Assume that national
income rises BP r1 a b O Y1 Y2 Deficit if rate of interest
remains at r1 Y ISLMBP analysis: fixed exchange rates
r BP
c r2
r1 a O Y1 Rate of interest must
rise to r2 to restore
balance of payments Y2 Y ISLMBP analysis: fixed exchange rates Full equilibrium in the
Full
goods, money and
foreign exchange markets ISLMBP analysis: fixed exchange rates
r LM BP
r1 a IS
O Y1
Full equilibrium in the goods, money
and foreign exchange markets Y ISLMBP analysis: fixed exchange rates Effect of an expansionary
Effect
fiscal policy
under fixed exchange rates ISLMBP analysis: fixed exchange rates
r LM1 b r2 r1 BP
a IS2
IS1
O Y1 Y2 An expansionary fiscal policy Y ISLMBP analysis: fixed exchange rates
r LM1 b r2 r1 BP
a Balance of payments
surplus causes money
supply to expand IS2
IS1
O Y1 Y2 An expansionary fiscal policy Y ISLMBP analysis: fixed exchange rates
r LM1 b r2
r
r1 LM BP
c
Restoration of
full equilibrium a IS2
IS1
O Y1 Y2 Y An expansionary fiscal policy Y ISLMBP analysis: fixed exchange rates
r BP
LM1 r1 a IS2
IS1
O Y1 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: fixed exchange rates
r BP
LM1
b r2
r1 a IS2
IS1
O Y1 Y2 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: fixed exchange rates
r BP
LM1
b r2
r1 a Balance of payments
deficit causes money
supply to contract IS2
IS1
O Y1 Y2 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: fixed exchange rates
r BP LM1 c r b r2
r1 LM Restoration of
full equilibrium a IS2
IS1
O Y1 Y Y2 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: fixed exchange rates Effect of an expansionary
Effect
monetary policy
under fixed exchange rates ISLMBP analysis: fixed exchange rates
r LM1 BP
r1 a IS
O Y1 An expansionary monetary policy Y ISLMBP analysis: fixed exchange rates
r LM1 LM2 BP
r1 a
b r2 IS
O Y1 Y2 An expansionary monetary policy Y ISLMBP analysis: fixed exchange rates
r LM1 LM2 BP
r1 a
b r2 Balance of payments
deficit causes money
supply to contract again IS
O Y1 Y2 An expansionary monetary policy Y ISLMBP analysis: fixed exchange rates
r LM1 LM2 BP
r1 a
b r2 Full equilibrium
is restored
back at point a IS
O Y1 Y2 An expansionary monetary policy Y ISLMBP analysis: floating exchange rates Floating exchange rates:
Floating
The BP curve ISLMBP analysis: floating exchange rates
r
SURPLUS
BP O Y ISLMBP analysis: floating exchange rates
r
SURPLUS Appreciation
BP O Y ISLMBP analysis: floating exchange rates
r BP DEFICIT O Y ISLMBP analysis: floating exchange rates
r BP Depreciation
DEFICIT O Y ISLMBP analysis: floating exchange rates Effect of an expansionary
Effect
fiscal policy
under floating exchange rates ISLMBP analysis: floating exchange rates
r LM
b r
2
r
1 BP a IS2
IS1
O Y1 Y2 An expansionary fiscal policy Y ISLMBP analysis: floating exchange rates
r LM
b r
2
r
1 BP a IS1 IS2 Balance of payments
surplus causes the
exchange rate to appreciate
O Y1 Y2 An expansionary fiscal policy Y ISLMBP analysis: floating exchange rates
r LM
b r
2
r
1 BP
The appreciation
causes the IS curve
to shift to the left a IS1 O Y1 Y2 An expansionary fiscal policy IS2 Y ISLMBP analysis: floating exchange rates
r LM r
2
r
r
1 BP
BP1 b
c Full equilibrium is
restored at point c a IS2
IS
IS1
O Y1 Y Y2 An expansionary fiscal policy Y ISLMBP analysis: floating exchange rates
r BP1 LM
r
r
2
1 a b IS2
IS1
O Y1 Y2 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: floating exchange rates
r BP1 LM
r
r
2
1 a b Balance of payments
deficit causes exchange
rate to depreciate IS2
IS1
O Y1 Y2 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: floating exchange rates
r BP1 LM
r
r
2
1 a b Depreciation causes
the IS curve to
shift to the right IS2
IS1
O Y1 Y2 An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: floating exchange rates
r BP1 r
r
r
2
1 a b c BP
LM
Full equilibrium is
achieved at point c IS
IS2
IS1
O Y1 Y2 Y An expansionary fiscal policy:
BP curve steeper than LM curve
LM Y ISLMBP analysis: floating exchange rates Effect of an expansionary
Effect
monetary policy
under floating exchange rates ISLMBP analysis: floating exchange rates
r LM1
LM2
BP1 r
1 a r
2 b IS1
O Y1 Y2 An expansionary monetary policy Y ISLMBP analysis: floating exchange rates
r LM1
LM2
BP1 r
1 a r
2 b The balance of payments
deficit causes the BP line
to shift downward IS1
O Y1 Y2 An expansionary monetary policy Y ISLMBP analysis: floating exchange rates
r LM1
LM2
BP1 r
1 a r
2 b The depreciation
causes the IS curve
to shift to the right IS1
O Y1 Y2 An expansionary monetary policy Y ISLMBP analysis: floating exchange rates
r LM1
LM2
BP1 r
1
r BP a r
2 c
b Full equilibrium is
restored at point c IS
IS1
O Y1 Y2 Y An expansionary monetary policy Y ...
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 Spring '11
 CROWDER
 Macroeconomics, Deficit, Monetary Policy, Foreign exchange market, foreign exchange markets, ISLMBP analysis

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