Download BOP in IS-LM Model

BOP in IS-LM Model
Internal Balance:
The attainment of the level of real income
consistent with the economy’s long run
growth path.
BOP in IS-LM Model
External Balance:
The attainment of some objective for private
international goods, services, income, and
assets.
BOP in IS-LM Model
External Balance means different things for
different policymakers.
BOP in IS-LM Model
External Balance means different things for different policymakers.
could mean:
• achieving trade surplus, or
It
BOP in IS-LM Model
External Balance means different things for different policymakers. It could
mean:
•
achieving trade surplus, or
• achieving surplus in their current account
(international trade and transfer of goods
and services and flows of income), or
BOP in IS-LM Model
External Balance means different things for different policymakers. It could
mean:
•
achieving trade surplus, or
•
achieving surplus in their current account (international trade and transfer of
goods and services and flows of income), or
• achieving balance in one or both
BOP in IS-LM Model
External Balance means different things for different policymakers. It could
mean:
• achieving trade surplus, or
• achieving surplus in their current account (international trade and transfer of
goods and services and flows of income), or
• achieving balance in one or both
• achieving balance in private transactions
such as zero balance after current and
capital accounts are added to prevent
government obligations.
BP Schedule
A set of real income-nominal interest rate
combinations that maintain a zero balance
for private payments - sometimes called a
“balance of payments equilibrium” in the
balance of payments accounts.
BP Schedule
Any point (A or B) on the BP schedule entails
external balance: zero private payment.
Interest rate
BP
B
r2
A
r1
Real income
y1
y2
BP Schedule
Starting from point A, if income rises to y2, imports
rises to higher level and a Deficit will develop (C).
This requires a higher interest rate to attract
foreign funds to cancel the trade deficit (B)
B
A
BP
C
Real income
y1
y2
BP Schedule
Interest rate
BP
B
A
C
Real income
y1
y2
BP Schedule
Assume the following dilemma:
• full employment income is at Y*
• equilibrium level of income is Y2
• equilibrium level of income that satisfies
equilibrium in the BP is Y1 .
• What should the central bank do?
BP Schedule
Interest rate
BP
LM
IS
Real income
y1
y2
Y*
Expansionary Monetary Policy would lead to full
employment but larger trade deficits
Interest rate
BP
LM
LM ’
IS
Real income
y1
y2
Y*
Contractionary Monetary Policy would exacerbate
employment but solves trade deficit problem
Interest rate
BP
LM ’
LM
IS
Real income
y1
y2
Y*