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Effects of Policy on Equilibrium in Open Economy

fiscal policy – assume increase of gov’t spending

 

  • affects IS curve >> shifts to the right
    • increases output, increases interest, increases exchange rate >> appreciates currency
    • interest increase makes domestic bonds more attractive >> appreciation of domestic currency
    • investment may or may not increase (output increases but interest increases as well)
    • net exports decrease (exchange rate increases >> exports decrease, output increases >> imports increase)
  • LM curve doesn’t shift

monetary policy – assume monetary contraction

 

  • shifts LM curve up
    • decreases output, increases interest rate >> appreciates currency
    • investment decreases for sure
    • net exports may or may not increase (output decreases but exchange rate decreases as well)
    • in medium run >> output decrease >> decrease in money demand, decrease in interest
  • IS curve doesn’t shift
  • affects both investment and interest parity condition (both through interest)
Subject: 
Economics
Subject X2: 
Economics

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