expansionary monetary policy reduces the interest rate while expansionary fiscal policy increases the interest rate. Accordingly, expansionary fiscal policy increases output while reducing the level of investment, expansionary monetary policy increases output. Governments have to choose the mix in accordance with their objectives for economic growth, or increasing consumption, or from the view point of their beliefs about the desirable size of the government. 4.4 EQUILIBRIUM IN AN OPEN ECONOMY The new tool of analysis take the form of BP curve. BP curve, showing equilibrium in the balance of payments. Short term capital is now assumed to be responsive to international interest rate differentials. 4.4.1 Balance of Payments Equilibrium : BP Curve The BP curve shows the various combinations of interest rates (I) and national income (Y) at which the nation's balance of payments is in equilibrium at a given exchange rate. The balance of payments is in equilibrium when a trade deficit is matched by an equal net capital inflow, a trade surplus is matched by an equal net capital outflow, or a zero trade balance is associated with a zero net international capital flow.
Monetary and Fiscal Policies in IS-LM Framework 80 BP CURVE Figure 4.9 : BP Curve
Monetary and Fiscal Policies in IS-LM Framework 81 Figure 4.10 : Equilibrium in the IS-LM-BP Curves
Monetary and Fiscal Policies in IS-LM Framework 82
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