Promoting active learning

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ISLM Analysis of the Open Economy (ISLMBP
Analysis)
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ISLMBP analysis fixed exchange rates

• Fixed exchange rates
• The BP curve

3
ISLMBP analysis fixed exchange rates
r
O
Y
4
ISLMBP analysis fixed exchange rates
r
BP
O
Y
5
ISLMBP analysis fixed exchange rates
r
BP
O
Y
6
ISLMBP analysis fixed exchange rates
r
Assume that national income rises
BP
a
r1
O
Y1
Y
7
ISLMBP analysis fixed exchange rates
r
Assume that national income rises
BP
a
r1
Deficit if rate of interest remains at r1
O
Y1
Y1
Y
8
ISLMBP analysis fixed exchange rates
r
BP
a
r1
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 rates
r
O
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 rates
r
LM1
BP
a
r1
IS1
O
Y1
Y
An expansionary fiscal policy
13
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
14
ISLMBP analysis fixed exchange rates
r
LM1
b
r2
BP
a
r1
IS2
IS1
O
Y1
Y2
Y
An expansionary fiscal policy
15
ISLMBP analysis fixed exchange rates
r
LM1
a
r1
IS1
O
Y1
Y
An expansionary fiscal policy BP curve steeper
than LM curve
16
ISLMBP analysis fixed exchange rates
r
BP
LM1
b
r2
a
r1
IS2
IS1
O
Y1
Y
An expansionary fiscal policy BP curve steeper
than LM curve
17
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
18
ISLMBP analysis fixed exchange rates
r
BP
LM1
b
r2
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 rates
r
LM1
BP
a
r1
IS
O
Y1
Y
An expansionary monetary policy
21
ISLMBP analysis fixed exchange rates
r
LM1
LM2
BP
a
r1
IS
O
Y1
Y
An expansionary monetary policy
22
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
23
ISLMBP analysis fixed exchange rates
r
LM1
LM2
BP
a
r1
b
r2
IS
O
Y1
Y2
Y
An expansionary monetary policy
24
ISLMBP analysis fixed exchange rates

• Floating exchange rates
• The BP curve

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ISLMBP analysis floating exchange rates
r
SURPLUS
O
Y
26
ISLMBP analysis floating exchange rates
r
BP
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
r
BP
O
Y
An expansionary fiscal policy
29
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
30
ISLMBP analysis floating exchange rates
r
LM
b
BP
r2
a
r1
IS2
IS1
O
Y2
Y1
Y
An expansionary fiscal policy
31
ISLMBP analysis floating exchange rates
r
LM
b
BP1
r2
a
r1
IS2
IS1
O
Y2
Y1
Y
An expansionary fiscal policy
32
ISLMBP analysis floating exchange rates
r
LM
a
r1
IS1
O
Y1
Y
An expansionary fiscal policy BP curve steeper
than LM curve
33
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
34
ISLMBP analysis floating exchange rates
r
BP1
LM
b
r2
a
r1
IS2
IS1
O
Y2
Y1
Y
An expansionary fiscal policy BP curve steeper
than LM curve
35
ISLMBP analysis floating exchange rates
r
BP1
LM
b
r2
a
r1
IS2
IS1
O
Y2
Y1
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
r
LM1
BP1
a
r1
IS1
O
Y1
Y
An expansionary monetary policy
38
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
39
ISLMBP analysis floating exchange rates
r
LM1
LM2
BP1
a
r1
r2
b
IS1
O
Y2
Y1
Y
An expansionary monetary policy
40
ISLMBP analysis floating exchange rates
r
LM1
LM2
BP1
a
r1
r2
b
IS1
O
Y2
Y1
Y
An expansionary monetary policy