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ISLM Analysis of the Open Economy ( ISLMBP Analysis) PowerPoint PPT Presentation


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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. BP. SURPLUS. r 1. DEFICIT. r. O. Y. ISLMBP analysis: fixed exchange rates. SURPLUS. DEFICIT. Y 1. r. BP.

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ISLM Analysis of the Open Economy ( ISLMBP Analysis)

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Islm analysis of the open economy islmbp analysis

ISLM Analysis of

the Open Economy

(ISLMBP Analysis)


Islmbp analysis fixed exchange rates

ISLMBP analysis: fixed exchange rates

Fixed exchange rates:

The BP curve


Islmbp analysis fixed exchange rates1

ISLMBP analysis: fixed exchange rates

BP

SURPLUS

r1

DEFICIT

r

O

Y


Islmbp analysis fixed exchange rates2

ISLMBP analysis: fixed exchange rates

SURPLUS

DEFICIT

Y1

r

BP

O

Y


Islmbp analysis fixed exchange rates3

ISLMBP analysis: fixed exchange rates

a

r1

Y1

r

BP

O

Y


Islmbp analysis fixed exchange rates4

ISLMBP analysis: fixed exchange rates

Y1

r

Assume that national

income rises

BP

a

r1

O

Y1

Y


Islmbp analysis fixed exchange rates5

ISLMBP analysis: fixed exchange rates

b

r

Assume that national

income rises

BP

a

r1

Deficit if rate of interest

remains at r1

O

Y1

Y1

Y


Islmbp analysis fixed exchange rates6

ISLMBP analysis: fixed exchange rates

c

r2

Rate of interest must

rise to r2 to restore

balance of payments

r

BP

a

r1

O

Y1

Y1

Y


Islmbp analysis fixed exchange rates7

ISLMBP analysis: fixed exchange rates

Full equilibrium in the

goods, money and

foreign exchange markets


Islmbp analysis fixed exchange rates8

ISLMBP analysis: fixed exchange rates

LM

BP

a

r1

IS

Y1

r

O

Y

Full equilibrium in the goods, money

and foreign exchange markets


Islmbp analysis fixed exchange rates9

ISLMBP analysis: fixed exchange rates

Effect of an expansionary

fiscal policy

under fixed

exchange rates


Islmbp analysis fixed exchange rates10

ISLMBP analysis: fixed exchange rates

b

r2

IS2

Y2

r

LM1

BP

a

r1

IS1

O

Y1

Y

An expansionary fiscal policy


Islmbp analysis fixed exchange rates11

ISLMBP analysis: fixed exchange rates

r

LM1

b

r2

BP

Balance of payments

surplus causes money

supply to expand

a

r1

IS2

IS1

O

Y1

Y2

Y

An expansionary fiscal policy


Islmbp analysis fixed exchange rates12

ISLMBP analysis: fixed exchange rates

LM2

c

r3

Restoration of

full equilibrium

Y3

r

LM1

b

r2

BP

a

r1

IS2

IS1

O

Y1

Y2

Y

An expansionary fiscal policy


Islmbp analysis fixed exchange rates13

ISLMBP analysis: fixed exchange rates

BP

IS2

r

LM1

a

r1

IS1

O

Y1

Y

An expansionary fiscal policy:

BP curve steeper than LM curve


Islmbp analysis fixed exchange rates14

ISLMBP analysis: fixed exchange rates

Y2

r

BP

LM1

b

r2

a

r1

IS2

IS1

O

Y1

Y

An expansionary fiscal policy:

BP curve steeper than LM curve


Islmbp analysis fixed exchange rates15

ISLMBP analysis: fixed exchange rates

r

BP

LM1

b

r2

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


Islmbp analysis fixed exchange rates16

ISLMBP analysis: fixed exchange rates

LM2

c

r3

Restoration of

full equilibrium

Y3

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 rates17

ISLMBP analysis: fixed exchange rates

Effect of an expansionary

monetary policy

under fixed exchange rates


Islmbp analysis fixed exchange rates18

ISLMBP analysis: fixed exchange rates

r

LM1

BP

a

r1

IS

O

Y1

Y

An expansionary monetary policy


Islmbp analysis fixed exchange rates19

ISLMBP analysis: fixed exchange rates

b

r2

Y2

r

LM1

LM2

BP

a

r1

IS

O

Y1

Y

An expansionary monetary policy


Islmbp analysis fixed exchange rates20

ISLMBP analysis: fixed exchange rates

r

LM1

LM2

BP

a

r1

Balance of payments

deficit causes money

supply to contract again

b

r2

IS

O

Y1

Y2

Y

An expansionary monetary policy


Islmbp analysis fixed exchange rates21

ISLMBP analysis: fixed exchange rates

Full equilibrium

is restored

back at point a

r

LM1

LM2

BP

a

r1

b

r2

IS

O

Y1

Y2

Y

An expansionary monetary policy


Islmbp analysis fixed exchange rates22

ISLMBP analysis: fixed exchange rates

Floating exchange rates:

The BP curve


Islmbp analysis floating exchange rates

ISLMBP analysis: floating exchange rates

Appreciation

BP

r

SURPLUS

O

Y


Islmbp analysis floating exchange rates1

ISLMBP analysis: floating exchange rates

Depreciation

r

BP

DEFICIT

O

Y


Islmbp analysis fixed exchange rates23

ISLMBP analysis: fixed exchange rates

Effect of an expansionary

fiscal policy

under floating

exchange rates


Islmbp analysis floating exchange rates2

ISLMBP analysis: floating exchange rates

LM

b

r2

a

r1

IS2

IS1

Y2

Y1

r

BP

O

Y

An expansionary fiscal policy


Islmbp analysis floating exchange rates3

ISLMBP analysis: floating exchange rates

r

LM

b

BP

r2

a

r1

IS2

IS1

Balance of payments

surplus causes the

exchange rate to appreciate

O

Y2

Y1

Y

An expansionary fiscal policy


Islmbp analysis floating exchange rates4

ISLMBP analysis: floating exchange rates

The appreciation

causes the IS curve

to shift to the left

r

LM

b

BP

r2

a

r1

IS2

IS1

O

Y2

Y1

Y

An expansionary fiscal policy


Islmbp analysis floating exchange rates5

ISLMBP analysis: floating exchange rates

BP2

c

r3

Full equilibrium is

restored at point c

IS3

Y3

r

LM

b

BP1

r2

a

r1

IS2

IS1

O

Y2

Y1

Y

An expansionary fiscal policy


Islmbp analysis floating exchange rates6

ISLMBP analysis: floating exchange rates

BP1

b

r2

IS2

Y2

r

LM

a

r1

IS1

O

Y1

Y

An expansionary fiscal policy:

BP curve steeper than LM curve


Islmbp analysis floating exchange rates7

ISLMBP analysis: floating exchange rates

r

BP1

LM

b

r2

Balance of payments

deficit causes exchange

rate to depreciate

a

r1

IS2

IS1

O

Y2

Y1

Y

An expansionary fiscal policy:

BP curve steeper than LM curve


Islmbp analysis floating exchange rates8

ISLMBP analysis: floating exchange rates

Depreciation causes

the IS curve to

shift to the right

r

BP1

LM

b

r2

a

r1

IS2

IS1

O

Y2

Y1

Y

An expansionary fiscal policy:

BP curve steeper than LM curve


Islmbp analysis floating exchange rates9

ISLMBP analysis: floating exchange rates

BP2

c

r3

Full equilibrium is

achieved at point c

IS3

Y3

r

BP1

LM

b

r2

a

r1

IS2

IS1

O

Y2

Y1

Y

An expansionary fiscal policy:

BP curve steeper than LM curve


Islmbp analysis fixed exchange rates24

ISLMBP analysis: fixed exchange rates

Effect of an expansionary

monetary policy

under floating

exchange rates


Islmbp analysis floating exchange rates10

ISLMBP analysis: floating exchange rates

LM2

r2

b

Y2

r

LM1

BP1

a

r1

IS1

O

Y1

Y

An expansionary monetary policy


Islmbp analysis floating exchange rates11

ISLMBP analysis: floating exchange rates

r

LM1

LM2

BP1

a

r1

The balance of payments

deficit causes the BP line

to shift downward

r2

b

IS1

O

Y2

Y1

Y

An expansionary monetary policy


Islmbp analysis floating exchange rates12

ISLMBP analysis: floating exchange rates

The depreciation

causes the IS curve

to shift to the right

r

LM1

LM2

BP1

a

r1

r2

b

IS1

O

Y2

Y1

Y

An expansionary monetary policy


Islmbp analysis floating exchange rates13

ISLMBP analysis: floating exchange rates

BP2

c

r3

Full equilibrium is

restored at point c

IS2

Y3

r

LM1

LM2

BP1

a

r1

r2

b

IS1

O

Y2

Y1

Y

An expansionary monetary policy


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