Consider the current macroeconomic environment in China. The government considers 8% GDP growth as its target...

Consider the current macroeconomic environment in China. The government considers 8% GDP growth as its target growth rate. But currently, Chinese policymakers feel the country will have trouble reaching this goal. They would like to increase Chinese GDP, using either fiscal or monetary policy. In our class, we have looked at the IS-LM –BOP framework to explore the effects of such policies on an economy. Use this framework to analyze policy choices in China. In particular:

What if China moved to a flexible exchange rate? Still assume perfect capital mobility

What would expansionary fiscal policy do for China? Use the IS-LM-BOP framework to analyze the effects on GDP, interest rates, and other indicators. Be sure to both draw the IS-LM-BOP AND explain these effects. Include changes to Y, i, P and other important indicators.

What would expansionary monetary policy do for China? Use the IS-LM-BOP framework to analyze the effects on GDP, interest rates, and other indicators. Be sure to both draw the IS-LM-BOP AND explain these effects. Include changes to Y, i, P and other important indicators

Solutions

Expert Solution

Ans:1(a)

The relationship between the equilibrium condition i.e. production is equal to the demand for goods in an open economy is called IS curve.

The relationship between the liquidity and money is called LM curve.

The BP curve shows the various combinations of production and interest rates

As per the facts given in the question if china moved to a flexible exchange rate through expansionary fiscal policy assuming perfect capital mobility then the effect of such policies on economy as per the IS-LM-BOP framework are:

1. It will shift the IS curve to IS’.

2. It will move the equilibrium from point E₀ to point E_1.

_3. It will appreciate the domestic currency.

4. It will decrease net exports and increase net imports since we are able to import more goods and services with less money whereas foreigners will be able to import less of our products due to depriciation in our currency.Thus the IS’ curve will shift back to its original position due to decrease in net exports.

5. Interest and investment have a negative relationship since increase in interest rate will decrease the investment and vise versa and so with the decrease in investment the production decreases.

The above diagram showing the effect of expansionary fiscal policy under flexible exchange rate.

Ans.2

As per the facts given in the question if china moved to a flexible exchange rate through expansionary monetary policy assuming perfect capital mobility then the effect of such policies on economy as per the IS-LM-BOP framework are:

1. It will shift the IS curve to IS’.

2. It will move the equilibrium from point E₀ to point E_1., but the final equilibrium is achieved at E2.

_3. It will shift LM curve to the right due to the increase in the money supply.

4.The interest rate will remain fixed.`

The above diagram showing the effect of expansionary monetary policy under flexible exchange rate.

Rahul Sunny answered 9 months ago

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