1. ISLM Analysis of
the Open Economy
(ISLMBP Analysis)

2. ISLMBP analysis: fixed exchange rates
The BP curve

3. ISLMBP analysis: fixed exchange rates
SURPLUS r1
DEFICIT O Y

4. ISLMBP analysis: fixed exchange rates
SURPLUS BP
DEFICIT O Y

5. ISLMBP analysis: fixed exchange ratesO Y

6. ISLMBP analysis: fixed exchange rates
Assume that national
income rises BP a r1 O Y1 Y1 Y

7. ISLMBP analysis: fixed exchange rates
Assume that national
income rises BP a b r1
Deficit if rate of interest
remains at r1 O Y1 Y1 Y

8. ISLMBP analysis: fixed exchange rates
Rate of interest must
rise to r2 to restore
balance of payments O Y1 Y1 Y

9. ISLMBP analysis: fixed exchange rates
Full equilibrium in the
goods, money and
foreign exchange markets

10. ISLMBP analysis: fixed exchange ratesO Y
Full equilibrium in the goods, money
and foreign exchange markets

11. ISLMBP analysis: fixed exchange rates
Effect of an expansionary
fiscal policy
under fixed
exchange rates

12. ISLMBP analysis: fixed exchange ratesO Y1 Y
An expansionary fiscal policy

13. ISLMBP analysis: fixed exchange rates
Balance of payments
surplus causes money
supply to expand a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy

14. ISLMBP analysis: fixed exchange rates
Restoration of
full equilibrium a Y3 r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy

15. ISLMBP analysis: fixed exchange ratesO Y1 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

16. ISLMBP analysis: fixed exchange ratesO Y1 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

17. ISLMBP analysis: fixed exchange rates
Balance of payments
deficit causes money
supply to contract a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

18. ISLMBP analysis: fixed exchange rates
Restoration of
full equilibrium a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

19. ISLMBP analysis: fixed exchange rates
Effect of an expansionary
monetary policy
under fixed exchange rates

20. ISLMBP analysis: fixed exchange ratesO Y1 Y
An expansionary monetary policy

21. ISLMBP analysis: fixed exchange ratesO Y1 Y
An expansionary monetary policy

22. ISLMBP analysis: fixed exchange rates
Balance of payments
deficit causes money
supply to contract again b r2 IS O Y1 Y2 Y
An expansionary monetary policy

23. ISLMBP analysis: fixed exchange rates
Full equilibrium
is restored
back at point a b r2 IS O Y1 Y2 Y
An expansionary monetary policy

24. ISLMBP analysis: fixed exchange rates
Floating exchange rates:
The BP curve

25. ISLMBP analysis: floating exchange rates
Appreciation
SURPLUS BP O Y

26. ISLMBP analysis: floating exchange rates
Depreciation
DEFICIT O Y

27. ISLMBP analysis: fixed exchange rates
Effect of an expansionary
fiscal policy
under floating
exchange rates

28. ISLMBP analysis: floating exchange rates
An expansionary fiscal policy

29. ISLMBP analysis: floating exchange rates
Balance of payments
surplus causes the
exchange rate to appreciate O Y1 Y2 Y
An expansionary fiscal policy

30. ISLMBP analysis: floating exchange rates
The appreciation
causes the IS curve
to shift to the left a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy

31. ISLMBP analysis: floating exchange rates
Full equilibrium is
restored at point c Y3 a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy

32. ISLMBP analysis: floating exchange rates
An expansionary fiscal policy:
BP curve steeper than LM curve

33. ISLMBP analysis: floating exchange rates
Balance of payments
deficit causes exchange
rate to depreciate a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

34. ISLMBP analysis: floating exchange rates
Depreciation causes
the IS curve to
shift to the right r2 a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

35. ISLMBP analysis: floating exchange rates
Full equilibrium is
achieved at point c b r2 Y3 a r1
IS2
IS1 O Y1 Y2 Y
An expansionary fiscal policy:
BP curve steeper than LM curve

36. ISLMBP analysis: fixed exchange rates
Effect of an expansionary
monetary policy
under floating
exchange rates

37. ISLMBP analysis: floating exchange rates
An expansionary monetary policy

38. ISLMBP analysis: floating exchange rates
The balance of payments
deficit causes the BP line
to shift downward r2 b
IS1 O Y1 Y2 Y
An expansionary monetary policy

39. ISLMBP analysis: floating exchange rates
The depreciation
causes the IS curve
to shift to the right r2 b
IS1 O Y1 Y2 Y
An expansionary monetary policy

40. ISLMBP analysis: floating exchange rates
Full equilibrium is
restored at point c
IS1 O Y1 Y2 Y
An expansionary monetary policy