Fixed exchange rates: The BP curve
Transcript of Fixed exchange rates: The BP curve
Fixed exchange rates:Fixed exchange rates:
TheThe BP BP curve curve
Fixed exchange rates:Fixed exchange rates:
TheThe BP BP curve curve
IS-LM-BPIS-LM-BP analysis: fixed exchange rates analysis: fixed exchange rates
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r1
SURPLUS
DEFICIT
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
BP
Zero Capital Flows
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r1
SURPLUS
DEFICIT
BP
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
Restricted Capital Flows
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SURPLUS
DEFICIT
Y1
BP
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
Restricted Capital Flows
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r1
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
Unrestricted Capital Flows
BP
DEFICIT
SURPLUS
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r1
Y1
a
BP
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
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r1
Y1
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Assume that nationalincome rises
Y2
BP
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
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r1
Y1
a
Y2
Assume that nationalincome rises
Deficit if rate of interestremains at r1
b
BP
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
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r1
Y1
a
Y2
Rate of interest mustrise to r2 to restore
balance of payments
cr2
BP
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
Full equilibrium in theFull equilibrium in thegoods, money andgoods, money and
foreign exchange marketsforeign exchange markets
Full equilibrium in theFull equilibrium in thegoods, money andgoods, money and
foreign exchange marketsforeign exchange markets
IS-LM-BPIS-LM-BP analysis: fixed exchange rates analysis: fixed exchange rates
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BP
LM
IS
r1
Y1
Full equilibrium in the goods, moneyFull equilibrium in the goods, moneyand foreign exchange marketsand foreign exchange markets
IS-LM-BP analysis: fixed exchange ratesIS-LM-BP analysis: fixed exchange rates
a
Effect of an expansionaryEffect of an expansionaryfiscal policyfiscal policy
under fixed exchange ratesunder fixed exchange rates
Effect of an expansionaryEffect of an expansionaryfiscal policyfiscal policy
under fixed exchange ratesunder fixed exchange rates
IS-LM-BPIS-LM-BP analysis: fixed exchange rates analysis: fixed exchange rates
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
r1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
a
r2
Y2
b
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
ar1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
r2
b
Y2
Balance of paymentssurplus causes money
supply to expand
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
ar1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
r2
b
Y2
Restoration of
full equilibrium
LM2
r3
Y3
c
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
r1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
IS2
a
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
r1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
IS2
a
r2
b
Y2
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
r1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
IS2
a
r2
b
Y2
Balance of paymentsdeficit causes money
supply to contract
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS1
r1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
IS2
a
r2
b
Y2
Restoration of
full equilibrium
LM2
r3
Y3
c
Effect of an expansionaryEffect of an expansionarymonetary policymonetary policy
under fixed exchange ratesunder fixed exchange rates
Effect of an expansionaryEffect of an expansionarymonetary policymonetary policy
under fixed exchange ratesunder fixed exchange rates
IS-LM-BPIS-LM-BP analysis: fixed exchange rates analysis: fixed exchange rates
IS-LM-BP analysis: fixed exchange rates
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r
Y
BP
LM1
IS
ar1
Y1
An expansionary monetary policyAn expansionary monetary policy
IS-LM-BP analysis: fixed exchange rates
O
r
Y
BP
LM1
IS
ar1
Y1
An expansionary monetary policyAn expansionary monetary policy
LM2
Y2
r2
b
IS-LM-BP analysis: fixed exchange rates
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r
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BP
LM1
IS
ar1
Y1
An expansionary monetary policyAn expansionary monetary policy
Y2
LM2
r2
bBalance of paymentsdeficit causes money
supply to contract again
IS-LM-BP analysis: fixed exchange rates
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BP
LM1
IS
ar1
Y1
An expansionary monetary policyAn expansionary monetary policy
Y2
LM2
r2
bFull equilibrium
is restoredback at point a
Floating exchange rates:Floating exchange rates:
TheThe BP BP curve curve
Floating exchange rates:Floating exchange rates:
TheThe BP BP curve curve
IS-LM-BPIS-LM-BP analysis: floating exchange rates analysis: floating exchange rates
IS-LM-BP analysis: floating exchange rates
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BP
SURPLUS
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BP
SURPLUSAppreciation
IS-LM-BP analysis: floating exchange ratesIS-LM-BP analysis: floating exchange rates
IS-LM-BP analysis: floating exchange rates
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BP
DEFICIT
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BP
DEFICIT
Depreciation
IS-LM-BP analysis: floating exchange ratesIS-LM-BP analysis: floating exchange rates
Effect of an expansionaryEffect of an expansionaryfiscal policyfiscal policy
under floating exchange ratesunder floating exchange rates
Effect of an expansionaryEffect of an expansionaryfiscal policyfiscal policy
under floating exchange ratesunder floating exchange rates
IS-LM-BPIS-LM-BP analysis: floating exchange rates analysis: floating exchange rates
IS-LM-BP analysis: floating exchange rates
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BP
LM
IS1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
Y2
r1
r2
b
a
IS-LM-BP analysis: floating exchange rates
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BP
LM
IS1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
a
Y2
r1
r2
b
Balance of paymentssurplus causes the
exchange rate to appreciate
IS-LM-BP analysis: floating exchange rates
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BP
LM
IS1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
a
Y2
r1
r2
b
The appreciationcauses the IS curve
to shift to the left
IS-LM-BP analysis: floating exchange rates
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BP1
LM
IS1
Y1
An expansionary fiscal policyAn expansionary fiscal policy
IS2
a
Y2
r1
r2
b
Full equilibrium isrestored at point c
BP2
IS3
Y3
r3
c
IS-LM-BP analysis: floating exchange rates
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LM
BP1
IS1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
ar1
IS2
Y2
r2b
IS-LM-BP analysis: floating exchange rates
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LM
BP1
IS1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
a
Y2
r1
r2b
IS2
Balance of paymentsdeficit causes exchange
rate to depreciate
IS-LM-BP analysis: floating exchange rates
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LM
BP1
IS1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
a
Y2
r1
r2b
IS2
Depreciation causesthe IS curve toshift to the right
IS-LM-BP analysis: floating exchange rates
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LM
BP1
IS1
Y1
An expansionary fiscal policy:An expansionary fiscal policy:BPBP curve steeper than curve steeper than LMLM curve curve
IS3
a
Y2
r1
r2b
BP2
IS2
Y3
r3c
Full equilibrium isachieved at point c
Effect of an expansionaryEffect of an expansionarymonetary policymonetary policy
under floating exchange ratesunder floating exchange rates
Effect of an expansionaryEffect of an expansionarymonetary policymonetary policy
under floating exchange ratesunder floating exchange rates
IS-LM-BPIS-LM-BP analysis: floating exchange rates analysis: floating exchange rates
IS-LM-BP analysis: floating exchange rates
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LM1
IS1
Y1
An expansionary monetary policyAn expansionary monetary policy
a
Y2
r1
r2
BP1
LM2
b
IS-LM-BP analysis: floating exchange rates
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LM1
IS1
Y1
An expansionary monetary policyAn expansionary monetary policy
a
Y2
r1
r2 b
The balance of paymentsdeficit causes the BP line
to shift downward
BP1
LM2
IS-LM-BP analysis: floating exchange rates
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LM1
IS1
Y1
An expansionary monetary policyAn expansionary monetary policy
a
Y2
r1
r2 b
The depreciationcauses the IS curveto shift to the right
BP1
LM2
IS-LM-BP analysis: floating exchange rates
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BP2
LM1
IS1
Y1
An expansionary monetary policyAn expansionary monetary policy
a
Y2
r1
r2 b Full equilibrium isrestored at point c
BP1
IS2
Y3
r3
LM2
c