Fixed exchange rates: The BP curve Fixed exchange rates: The BP curve IS-LM-BP analysis: fixed exchange rates.

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Presentation transcript:

Fixed exchange rates: The BP curve Fixed exchange rates: The BP curve IS-LM-BP analysis: fixed exchange rates

O r Y r1r1 SURPLUS DEFICIT IS-LM-BP analysis: fixed exchange rates BP Zero Capital Flows

O r Y r1r1 SURPLUS DEFICIT BP IS-LM-BP analysis: fixed exchange rates Restricted Capital Flows

O r Y SURPLUS DEFICIT Y1Y1 BP IS-LM-BP analysis: fixed exchange rates Restricted Capital Flows

O r Y r1r1 IS-LM-BP analysis: fixed exchange rates Unrestricted Capital Flows BP DEFICIT SURPLUS

O r Y r1r1 Y1Y1 a BP IS-LM-BP analysis: fixed exchange rates

O r Y r1r1 Y1Y1 a Assume that national income rises Y2Y2 BP IS-LM-BP analysis: fixed exchange rates

O r Y r1r1 Y1Y1 a Y2Y2 Assume that national income rises Deficit if rate of interest remains at r 1 b BP IS-LM-BP analysis: fixed exchange rates

O r Y r1r1 Y1Y1 a Y2Y2 Rate of interest must rise to r 2 to restore balance of payments c r2r2 BP IS-LM-BP analysis: fixed exchange rates

Full equilibrium in the goods, money and foreign exchange markets Full equilibrium in the goods, money and foreign exchange markets IS-LM-BP analysis: fixed exchange rates

O r Y BP LM IS r1r1 Y1Y1 Full equilibrium in the goods, money and foreign exchange markets IS-LM-BP analysis: fixed exchange rates a

Effect of an expansionary fiscal policy under fixed exchange rates Effect of an expansionary fiscal policy under fixed exchange rates IS-LM-BP analysis: fixed exchange rates

O r Y BP LM 1 IS 1 r1r1 Y1Y1 An expansionary fiscal policy IS 2 a r2r2 Y2Y2 b

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 a r1r1 Y1Y1 An expansionary fiscal policy IS 2 r2r2 b Y2Y2 Balance of payments surplus causes money supply to expand

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 a r1r1 Y1Y1 An expansionary fiscal policy IS 2 r2r2 b Y2Y2 Restoration of full equilibrium LM 2 r3r3 Y3Y3 c

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r1r1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r1r1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a r2r2 b Y2Y2

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r1r1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a r2r2 b Y2Y2 Balance of payments deficit causes money supply to contract

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r1r1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a r2r2 b Y2Y2 Restoration of full equilibrium LM 2 r3r3 Y3Y3 c

Effect of an expansionary monetary policy under fixed exchange rates Effect of an expansionary monetary policy under fixed exchange rates IS-LM-BP analysis: fixed exchange rates

O r Y BP LM 1 IS a r1r1 Y1Y1 An expansionary monetary policy

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r1r1 Y1Y1 An expansionary monetary policy LM 2 Y2Y2 r2r2 b

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r1r1 Y1Y1 An expansionary monetary policy Y2Y2 LM 2 r2r2 b Balance of payments deficit causes money supply to contract again

IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r1r1 Y1Y1 An expansionary monetary policy Y2Y2 LM 2 r2r2 b Full equilibrium is restored back at point a

Floating exchange rates: The BP curve Floating exchange rates: The BP curve IS-LM-BP analysis: floating exchange rates

O r Y BP SURPLUS

O r Y BP SURPLUS Appreciation IS-LM-BP analysis: floating exchange rates

O r Y BP DEFICIT

O r Y BP DEFICIT Depreciation IS-LM-BP analysis: floating exchange rates

Effect of an expansionary fiscal policy under floating exchange rates Effect of an expansionary fiscal policy under floating exchange rates IS-LM-BP analysis: floating exchange rates

O r Y BP LM IS 1 Y1Y1 An expansionary fiscal policy IS 2 Y2Y2 r1r1 r2r2 b a

IS-LM-BP analysis: floating exchange rates O r Y BP LM IS 1 Y1Y1 An expansionary fiscal policy IS 2 a Y2Y2 r1r1 r2r2 b Balance of payments surplus causes the exchange rate to appreciate

IS-LM-BP analysis: floating exchange rates O r Y BP LM IS 1 Y1Y1 An expansionary fiscal policy IS 2 a Y2Y2 r1r1 r2r2 b The appreciation causes the IS curve to shift to the left

IS-LM-BP analysis: floating exchange rates O r Y BP 1 LM IS 1 Y1Y1 An expansionary fiscal policy IS 2 a Y2Y2 r1r1 r2r2 b Full equilibrium is restored at point c BP 2 IS 3 Y3Y3 r3r3 c

IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve a r1r1 IS 2 Y2Y2 r2r2 b

IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve a Y2Y2 r1r1 r2r2 b IS 2 Balance of payments deficit causes exchange rate to depreciate

IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve a Y2Y2 r1r1 r2r2 b IS 2 Depreciation causes the IS curve to shift to the right

IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y1Y1 An expansionary fiscal policy: BP curve steeper than LM curve IS 3 a Y2Y2 r1r1 r2r2 b BP 2 IS 2 Y3Y3 r3r3 c Full equilibrium is achieved at point c

Effect of an expansionary monetary policy under floating exchange rates Effect of an expansionary monetary policy under floating exchange rates IS-LM-BP analysis: floating exchange rates

O r Y LM 1 IS 1 Y1Y1 An expansionary monetary policy a Y2Y2 r1r1 r2r2 BP 1 LM 2 b

IS-LM-BP analysis: floating exchange rates O r Y LM 1 IS 1 Y1Y1 An expansionary monetary policy a Y2Y2 r1r1 r2r2 b The balance of payments deficit causes the BP line to shift downward BP 1 LM 2

IS-LM-BP analysis: floating exchange rates O r Y LM 1 IS 1 Y1Y1 An expansionary monetary policy a Y2Y2 r1r1 r2r2 b The depreciation causes the IS curve to shift to the right BP 1 LM 2

IS-LM-BP analysis: floating exchange rates O r Y BP 2 LM 1 IS 1 Y1Y1 An expansionary monetary policy a Y2Y2 r1r1 r2r2 b Full equilibrium is restored at point c BP 1 IS 2 Y3Y3 r3r3 LM 2 c