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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.

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BOP in IS-LM Model

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  1. BOP in IS-LM Model Internal Balance: The attainment of the level of real income consistent with the economy’s long run growth path.

  2. BOP in IS-LM Model External Balance: The attainment of some objective for private international goods, services, income, and assets.

  3. BOP in IS-LM Model External Balance means different things for different policymakers.

  4. BOP in IS-LM Model External Balance means different things for different policymakers. It could mean: • achieving trade surplus, or

  5. 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

  6. 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

  7. 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.

  8. 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.

  9. 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

  10. 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 BP A C Real income y1 y2

  11. BP Schedule BP Interest rate B A C Real income y1 y2

  12. 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?

  13. BP Schedule BP Interest rate LM IS Real income y1 y2 Y*

  14. Expansionary Monetary Policy would lead to full employment but larger trade deficits BP Interest rate LM LM ’ IS Real income y1 y2 Y*

  15. Contractionary Monetary Policy would exacerbate employment but solves trade deficit problem BP Interest rate LM ’ LM IS Real income y1 y2 Y*

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