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Is LM BP Analysis

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1) The document discusses ISLM analysis of open economies under fixed and floating exchange rates. 2) Under fixed exchange rates, an expansionary fiscal policy can cause a balance of payments deficit and the interest rate must rise to restore equilibrium. 3) Under floating exchange rates, an expansionary fiscal policy causes the exchange rate to appreciate, shifting the IS curve left and restoring equilibrium at a higher interest rate and output level.

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Download as PPT, PDF, TXT or read online from Scribd
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Is LM BP Analysis

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api-3825580
2K views40 pages
1) The document discusses ISLM analysis of open economies under fixed and floating exchange rates. 2) Under fixed exchange rates, an expansionary fiscal policy can cause a balance of payments deficit and the interest rate must rise to restore equilibrium. 3) Under floating exchange rates, an expansionary fiscal policy causes the exchange rate to appreciate, shifting the IS curve left and restoring equilibrium at a higher interest rate and output level.

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1) The document discusses ISLM analysis of open economies under fixed and floating exchange rates. 2) Under fixed exchange rates, an expansionary fiscal policy can cause a balance of payments deficit and the interest rate must rise to restore equilibrium. 3) Under floating exchange rates, an expansionary fiscal policy causes the exchange rate to appreciate, shifting the IS curve left and restoring equilibrium at a higher interest rate and output level.

Copyright:

Attribution Non-Commercial (BY-NC)
Download as PPT, PDF, TXT or read online from Scribd
Download as ppt, pdf, or txt
2K views40 pages

Is LM BP Analysis

Uploaded by

api-3825580
1) The document discusses ISLM analysis of open economies under fixed and floating exchange rates. 2) Under fixed exchange rates, an expansionary fiscal policy can cause a balance of payments deficit and the interest rate must rise to restore equilibrium. 3) Under floating exchange rates, an expansionary fiscal policy causes the exchange rate to appreciate, shifting the IS curve left and restoring equilibrium at a higher interest rate and output level.

Copyright:

Attribution Non-Commercial (BY-NC)
Download as PPT, PDF, TXT or read online from Scribd
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ISLM Analysis of

the Open Economy


(ISLMBP Analysis)
ISLMBP analysis: fixed exchange rates

Fixed exchange rates:


The BP curve
ISLMBP analysis: fixed exchange rates
r

BP

SURPLUS
r1
DEFICIT

O
Y
ISLMBP analysis: fixed exchange rates
r

SURPLUS BP

DEFICIT

O Y1 Y
ISLMBP analysis: fixed exchange rates
r

BP

a
r1

O Y1 Y
ISLMBP analysis: fixed exchange rates
r
Assume that national
income rises
BP

a
r1

O Y1 Y1 Y
ISLMBP analysis: fixed exchange rates
r
Assume that national
income rises
BP

a b
r1 Deficit if rate of interest
remains at r1

O Y1 Y1 Y
ISLMBP analysis: fixed exchange rates
r

BP
c
r2
a
r1 Rate of interest must
rise to r2 to restore
balance of payments

O Y1 Y1 Y
ISLMBP analysis: fixed exchange rates

Full equilibrium in the


goods, money and
foreign exchange
markets
ISLMBP analysis: fixed exchange rates
r LM

BP

a
r1

IS

O Y1
Y
Full equilibrium in the goods, money
and foreign exchange markets
ISLMBP analysis: fixed exchange rates

Effect of an expansionary
fiscal policy
under fixed
exchange rates
ISLMBP analysis: fixed exchange rates
r LM1

b
r2 BP

a
r1

IS2

IS1

O Y1 Y2 Y
An expansionary fiscal policy
ISLMBP analysis: fixed exchange rates
r LM1

b
r2 BP

Balance of payments
a
r1 surplus causes money
supply to expand

IS2

IS1

O Y1 Y2 Y
An expansionary fiscal policy
ISLMBP analysis: fixed exchange rates
r LM1
LM2

b
r2 BP
c
r3
a Restoration of
r1 full equilibrium

IS2

IS1

O Y1 Y2 Y3 Y
An expansionary fiscal policy
ISLMBP analysis: fixed exchange rates
r BP

LM1

a
r1

IS2

IS1

O Y1
Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: fixed exchange rates
r BP

LM1

b
r2
a
r1

IS2

IS1

O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: fixed exchange rates
r BP

LM1

b
r2 Balance of payments
a deficit causes money
r1 supply to contract

IS2

IS1

O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: fixed exchange rates
r BP LM2

LM1
c
r3
b
r2
Restoration of
a
r1 full equilibrium

IS2

IS1

O Y1 Y3 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: fixed exchange rates

Effect of an expansionary
monetary policy
under fixed exchange
rates
ISLMBP analysis: fixed exchange rates
r LM1

BP

a
r1

IS

O Y1 Y
An expansionary monetary policy
ISLMBP analysis: fixed exchange rates
r LM1
LM2

BP

a
r1
b
r2

IS

O Y1 Y2 Y
An expansionary monetary policy
ISLMBP analysis: fixed exchange rates
r LM1
LM2

BP

a
r1 Balance of payments
b deficit causes money
r2
supply to contract again

IS

O Y1 Y2 Y
An expansionary monetary policy
ISLMBP analysis: fixed exchange rates
r LM1
LM2

BP

a
r1 Full equilibrium
b is restored
r2
back at point a

IS

O Y1 Y2 Y
An expansionary monetary policy
ISLMBP analysis: fixed exchange rates

Floating exchange rates:


The BP curve
ISLMBP analysis: floating exchange rates
r
Appreciation
SURPLUS

BP

O
Y
ISLMBP analysis: floating exchange rates
r

BP

Depreciation
DEFICIT

O
Y
ISLMBP analysis: fixed exchange rates

Effect of an expansionary
fiscal policy
under floating
exchange rates
ISLMBP analysis: floating exchange rates
r
LM

b
r2 BP

a
r1

IS2

IS1

O Y1 Y2 Y
An expansionary fiscal policy
ISLMBP analysis: floating exchange rates
r
LM

b
r2 BP

a
r1

IS1 IS2
Balance of payments
surplus causes the
exchange rate to appreciate

O Y1 Y2 Y
An expansionary fiscal policy
ISLMBP analysis: floating exchange rates
r
LM

b
r2 BP
The appreciation
a causes the IS curve
r1
to shift to the left

IS1 IS2

O Y1 Y2 Y
An expansionary fiscal policy
ISLMBP analysis: floating exchange rates
r
LM

b BP2
r2 BP1
c
r3
Full equilibrium is
a
r1 restored at point c

IS2

IS3
IS1
O Y1 Y3 Y2 Y
An expansionary fiscal policy
ISLMBP analysis: floating exchange rates
r
BP1

LM

r2 b
a
r1

IS2
IS1
O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: floating exchange rates
r
BP1

LM

r2 b
a Balance of payments
r1 deficit causes exchange
rate to depreciate

IS2
IS1
O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: floating exchange rates
r
BP1

LM

r2 b Depreciation causes
a
r1 the IS curve to
shift to the right

IS2
IS1
O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: floating exchange rates
r
BP1
BP2

LM
r3 c
b Full equilibrium is
r2 a
r1 achieved at point c

IS3

IS2
IS1
O Y1 Y2 Y3 Y
An expansionary fiscal policy:
BP curve steeper than LM curve
ISLMBP analysis: fixed exchange rates

Effect of an expansionary
monetary policy
under floating
exchange rates
ISLMBP analysis: floating exchange rates
r
LM1
LM2

BP1

a
r1

r2 b

IS1
O Y1 Y2 Y
An expansionary monetary policy
ISLMBP analysis: floating exchange rates
r
LM1
LM2

BP1

a
r1
The balance of payments
r2 b deficit causes the BP line
to shift downward

IS1
O Y1 Y2 Y
An expansionary monetary policy
ISLMBP analysis: floating exchange rates
r
LM1
LM2

BP1

a
r1
The depreciation
r2 b causes the IS curve
to shift to the right

IS1
O Y1 Y2 Y
An expansionary monetary policy
ISLMBP analysis: floating exchange rates
r
LM1
LM2

BP1

a BP2
r1
c
r3
r2 b Full equilibrium is
restored at point c

IS2
IS1
O Y1 Y2 Y3 Y
An expansionary monetary policy

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