Explain in detail the policy conclusions of the IS/LM/BP model

Solutions

Expert Solution

ISLMBP model is also known as mundell Fleming model. IS curve represents goods market equilibrium and LM curve represents money market equilibrium and BP curve represents Balance of payment equilibrium.It is an extension of ISLM model in an open economy.

ISLMBP model explain with the policy implications. This can be explained with the help of following diagrams.

Under Fixed exchange rate system

If an expansionary monetary policy under fixed exchange rate system shifts the LM curve to the right. Which is below the BOP (balance of payment deficit). In order to overcome the problem and maintain initial equilibrium, government purchase domestic currencies. As a result LM shifts back to the normal position . Monetary policy has no effect under fixed exchange rate system. An expansionary fiscal policy shifts IS to the right.new equilibrium point is established at E2.there is BOP surplus in the economy. Here government intervention is essential. So government purchase foreign currencies and sell domestic currency. So that money supply increases and the LM curve shifts to the right. And with the same interest rate new equilibrium point is established. Fiscal policy is effective under fixed exchange rate system.

2. Under flexible exchange rate system

If expansionary monetary policy is introduced, the LM curve shifts to the right and new equilibrium point is established. Now country has BOP deficit that depreciate domestic currency.which means foreigners now can purchase more quantities than before. As a result IS shifts to the right and at the same rate of interest new equilibrium point is established.here monetary policy is highly effective. If expansionary fiscal policy introduced in the economy, IS curve shifts to the right. New equilibrium point is established. Now country has BOP surplus. But they domestic country's currency appreciates. So net imports of foreigners come down as a result IS shifts back to its original position (IS to IS1)

Rahul Sunny answered 3 months ago

Next > < Previous

Related Solutions

(a) Using the IS-LM-BP model, explain the effects of a decrease in foreign price on domestic...

(a) Using the IS-LM-BP model, explain the effects of a decrease in foreign price on domestic economy under a flexible exchanger rate (b) Assumed that the BP curve is steeper than the LM curve. Using the IS-LM-MP model, analyze the effectiveness of the expansionary in fiscal and monetary policy under flexible exchange rates.

Compare the Closed-Economy IS-LM model, an Open-Economy IS-LM-BP model in which exchange rates are allowed to...

Compare the Closed-Economy IS-LM model, an Open-Economy IS-LM-BP model in which exchange rates are allowed to float freely, and an Open-Economy IS-LM-BP model in which exchange rates are held constant by the central bank. Specifically, use the three models to explain, and compare, the effects on GDP, interest, and the exchange rate of the national currency of: a. A sudden increase in government expenditures. b. A sharp increase in the discount rate and a massive sale of Treasury bonds by...

Consider the IS-LM-BP model, where the BP curve is horizontal with perfect capital mobility. A decrease...

Consider the IS-LM-BP model, where the BP curve is horizontal with perfect capital mobility. A decrease in foreign interest rates will lead to a BoP deficit and a depletion in the Central Bank’s official foreign exchange reserves under fixed exchange rate regime. it is a true/false question and could you explain it briefly please?

Explain, using the IS/LM/BP model, how an increase in foreign interest rates can lead to an...

Explain, using the IS/LM/BP model, how an increase in foreign interest rates can lead to an increase in domestic interest rates.

Using the IS/LM/BP model and assuming perfect capital mobility, explain: a. how an increase in foreign...

Using the IS/LM/BP model and assuming perfect capital mobility, explain: a. how an increase in foreign income affects domestic output. b. how a devaluation of the domestic currency affects domestic output.

Explain, using the IS/LM/BP model, how an increase in foreign interest rates can lead to an...

Explain, using the IS/LM/BP model, how an increase in foreign interest rates can lead to an increase in domestic interest rates.

Explain the effectiveness of monetary policy when capital mobility is zero (Use IS-LM-BP curves to answer...

Explain the effectiveness of monetary policy when capital mobility is zero (Use IS-LM-BP curves to answer the above questions)

As a review of the theoretical discussion of the IS-LM-BP model, do the following exercises: a)...

As a review of the theoretical discussion of the IS-LM-BP model, do the following exercises: a) Using the IS-LM-BP model, explain the effect of restrictive monetary policy on output when there is a flexible exchange rate regime and perfect capital mobility. b) How does the analysis in (a) changes if there is not perfect capital mobility? c) Using the IS-LM-BP model, explain how, with a fixed exchange rate regime, the government can reduce unemployment with a combination of expansionary fiscal...

Assume that the IS-LM-BP model is an accurate abstraction of a real economy, and use the...

Assume that the IS-LM-BP model is an accurate abstraction of a real economy, and use the model to describe how the macroeconomic effects of a tightening of monetary policy differ between a closed economy and an open economy. Hint: be sure to first describe the IS-LM-BP model, and then show how fiscal policy shifts the curves and the economy reached a new equilibrium.

Explain the IS-LM model?

Subjects