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Fixed exchange rates: The BP curve

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Fixed exchange rates: The BP curve

  1. 1. Fixed exchange rates: The BP curve IS-LM-BP analysis: fixed exchange rates
  2. 2. IS-LM-BP analysis: fixed exchange rates O r Y BP Zero Capital Flows r 1 SURPLUS DEFICIT
  3. 3. IS-LM-BP analysis: fixed exchange rates O r Y Restricted Capital Flows r 1 SURPLUS DEFICIT BP
  4. 4. IS-LM-BP analysis: fixed exchange rates O r Y BP Restricted Capital Flows SURPLUS DEFICIT Y 1
  5. 5. IS-LM-BP analysis: fixed exchange rates O r Y Unrestricted Capital Flows BP r 1 DEFICIT SURPLUS
  6. 6. IS-LM-BP analysis: fixed exchange rates O r Y BP r 1 Y 1 a
  7. 7. IS-LM-BP analysis: fixed exchange rates O r Y r 1 Y 1 a Assume that national income rises BP Y 2
  8. 8. IS-LM-BP analysis: fixed exchange rates O r Y r 1 Y 1 a Y 2 Assume that national income rises Deficit if rate of interest remains at r 1 BP b
  9. 9. IS-LM-BP analysis: fixed exchange rates O r Y r 1 Y 1 a Y 2 BP Rate of interest must rise to r 2 to restore balance of payments c r 2
  10. 10. Full equilibrium in the goods, money and foreign exchange markets IS-LM-BP analysis: fixed exchange rates
  11. 11. IS-LM-BP analysis: fixed exchange rates O r Y Full equilibrium in the goods, money and foreign exchange markets BP LM IS r 1 Y 1 a
  12. 12. Effect of an expansionary fiscal policy under fixed exchange rates IS-LM-BP analysis: fixed exchange rates
  13. 13. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r 1 Y 1 An expansionary fiscal policy a IS 2 r 2 Y 2 b
  14. 14. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 a r 1 Y 1 An expansionary fiscal policy IS 2 r 2 b Y 2 Balance of payments surplus causes money supply to expand
  15. 15. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 a r 1 Y 1 An expansionary fiscal policy IS 2 r 2 b Y 2 Restoration of full equilibrium LM 2 r 3 Y 3 c
  16. 16. IS-LM-BP analysis: fixed exchange rates O r Y LM 1 IS 1 r 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve a BP IS 2
  17. 17. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a r 2 b Y 2
  18. 18. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a r 2 b Y 2 Balance of payments deficit causes money supply to contract
  19. 19. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS 1 r 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve IS 2 a r 2 b Y 2 Restoration of full equilibrium LM 2 r 3 Y 3 c
  20. 20. Effect of an expansionary monetary policy under fixed exchange rates IS-LM-BP analysis: fixed exchange rates
  21. 21. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r 1 Y 1 An expansionary monetary policy
  22. 22. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r 1 Y 1 An expansionary monetary policy LM 2 Y 2 r 2 b
  23. 23. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r 1 Y 1 An expansionary monetary policy Y 2 LM 2 r 2 b Balance of payments deficit causes money supply to contract again
  24. 24. IS-LM-BP analysis: fixed exchange rates O r Y BP LM 1 IS a r 1 Y 1 An expansionary monetary policy Y 2 LM 2 r 2 b Full equilibrium is restored back at point a
  25. 25. Floating exchange rates: The BP curve IS-LM-BP analysis: floating exchange rates
  26. 26. IS-LM-BP analysis: floating exchange rates O r Y SURPLUS BP
  27. 27. IS-LM-BP analysis: floating exchange rates O r Y BP SURPLUS Appreciation
  28. 28. IS-LM-BP analysis: floating exchange rates O r Y BP DEFICIT
  29. 29. IS-LM-BP analysis: floating exchange rates O r Y BP DEFICIT Depreciation
  30. 30. Effect of an expansionary fiscal policy under floating exchange rates IS-LM-BP analysis: floating exchange rates
  31. 31. IS-LM-BP analysis: floating exchange rates O r Y BP An expansionary fiscal policy LM IS 1 Y 1 IS 2 Y 2 r 1 r 2 b a
  32. 32. IS-LM-BP analysis: floating exchange rates O r Y BP LM IS 1 Y 1 An expansionary fiscal policy IS 2 a Y 2 r 1 r 2 b Balance of payments surplus causes the exchange rate to appreciate
  33. 33. IS-LM-BP analysis: floating exchange rates O r Y BP LM IS 1 Y 1 An expansionary fiscal policy IS 2 a Y 2 r 1 r 2 b The appreciation causes the IS curve to shift to the left
  34. 34. IS-LM-BP analysis: floating exchange rates O r Y BP 1 LM IS 1 Y 1 An expansionary fiscal policy IS 2 a Y 2 r 1 r 2 b Full equilibrium is restored at point c BP 2 IS 3 Y 3 r 3 c
  35. 35. IS-LM-BP analysis: floating exchange rates O r Y LM IS 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve a r 1 BP 1 IS 2 Y 2 r 2 b
  36. 36. IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve a Y 2 r 1 r 2 b IS 2 Balance of payments deficit causes exchange rate to depreciate
  37. 37. IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve a Y 2 r 1 r 2 b IS 2 Depreciation causes the IS curve to shift to the right
  38. 38. IS-LM-BP analysis: floating exchange rates O r Y LM BP 1 IS 1 Y 1 An expansionary fiscal policy: BP curve steeper than LM curve a Y 2 r 1 r 2 b IS 2 IS 3 BP 2 Y 3 r 3 c Full equilibrium is achieved at point c
  39. 39. Effect of an expansionary monetary policy under floating exchange rates IS-LM-BP analysis: floating exchange rates
  40. 40. IS-LM-BP analysis: floating exchange rates O r Y LM 1 IS 1 Y 1 An expansionary monetary policy a r 1 BP 1 Y 2 r 2 LM 2 b
  41. 41. IS-LM-BP analysis: floating exchange rates O r Y LM 1 IS 1 Y 1 An expansionary monetary policy a Y 2 r 1 r 2 b The balance of payments deficit causes the BP line to shift downward BP 1 LM 2
  42. 42. IS-LM-BP analysis: floating exchange rates O r Y LM 1 IS 1 Y 1 An expansionary monetary policy a Y 2 r 1 r 2 b BP 1 LM 2 The depreciation causes the IS curve to shift to the right
  43. 43. IS-LM-BP analysis: floating exchange rates O r Y LM 1 IS 1 Y 1 An expansionary monetary policy a Y 2 r 1 r 2 b BP 1 LM 2 BP 2 Full equilibrium is restored at point c IS 2 Y 3 r 3 c

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