show on the IS-LM graph: What are the effects of a contractionary fiscal policy abroad on...

show on the IS-LM graph:

What are the effects of a contractionary fiscal policy abroad on the Canadian output and interest rate?

What are the effects of a contractionary monetary policy abroad on the Canadian output and interest rate?

Expert Solution

In each graph, interest rate (r) and output (Y) are measured vertically and horizontally respectively. IS0 & LM0 are initial IS & LM curves, intersecting at point A with initial interest rate r0 & output Y0.

(1) A contractionary fiscal policy abroad will lower the real GDP abroad, which will decrease their import demand, so exports of Canada will fall, lowering trade balance. Since trade balance equals Savings less investment, lower exports will decrease saving less investment, shifting IS curve leftward, lowering both interest rate and output. In following graph, as IS0 shifts left to IS1, it intersects LM0 at point B with lower interest rate r1 and lower output Y1.

(2) A contractionary monetary policy abroad will increase the interest rate abroad, which will increase foreign investment abroad and decrease foreign investment in Canada, which will shift IS curve leftward, lowering both interest rate and output. In following graph, as IS0 shifts left to IS1, it intersects LM0 at point B with lower interest rate r1 and lower output Y1.

Rahul Sunny answered 2 years ago

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