OE Graphs Flashcards
How will an increase in iF affect the UIP diagram?
the domestic return on foreign investment line will shift leftwards
Keynesian Cross: An increase in domestic government spending
Domestic Expenditure and Expenditure shift upwards. NX does not shift as changes in G only affect Y, and NX is plotted against Y. NX does drop and trade balance worsens
Keynesian Cross diagram: increase in foreign G
Domestic Expenditure and Expenditure shift upwards. NX shifts upwards- more spending abroad implies more spending on exports from the economy
Keynesian Cross: real depreciation
Domestic Expenditure shifts upwards, NX shifts upwards - a real depreciation means domestic goods are more attractive domestically and abroad. therefore more exports, fewer imports, leading to more spending domestically => more output.
CE IS vs OE IS
OE IS line is flatter since output is more sensitive to changes in the interest rate. drop in i stimulates more production through both more investment and depreciation of domestic currency. Weaker investment channel than in a closed economy
Floating Rates OE IS LM: a monetary expansion
LM shifts down, i drops in FX markets, NX shifts upwards (improves trade balance).
Floating rates OE IS-LM: a fiscal expansion
IS line shifts upwards. No change in iD/F, NX slides right - decrease
Fixed Rates OE IS-LM: a devaluation
iD/F shifts left, IS line shifts up, NX line shifts up. Drop in E => actual and expected interest rates decrease. Fixed prices so nominal devaluation leads to real one increasing competitiveness of domestic goods, stimulating output.
Fixed rates OE IS-LM: Currency crisis
IS line shifts up, LM line shifts up, iD/F line shifts left, i shifts up, NX slides left. No change in NX as exchange rate is held constant.
Expected exchange rate drops => there’s more spending for any interest rate. CB defends currency by raising interest rate.
Fixed rates OE IS-LM: attack on strong currency
IS shifts down, LM shifts down, iD/F shifts right, i shifts down, NX slides right.
Since E is fixed, i must drop and so investment increases meaning Y* increases.
Regime Comparisons: Countering positive demand side shock
IS line shift right
Floating rate: LM and i line shifts up to restore previous level of spending
Fixed rate: Nothing can be done
Regime Comparison: Countering supply side shock (Y* < Yn)
floating rate: LM and i line shift downwards to equate output and potential output
fixed rate: LM line doesn’t move and so economy is stuck with its current level of production
Countering Expectations Shock (floating rate regime) - domestic currency expected to depreciate
iD/F shifts left, IS shifts up, LM shifts up, i shifts up
Under a floating rate regime how can we achieve balanced trade with a trade balance deficit
LM and i shift downwards, IS shifts downwards, NX shifts upwards so Y = Y*
intuition - CB lowers policy rate, depreciates currency. depreciation of currency makes goods more competitive, net exports increase. Fiscal tightening lowers level of output achieving balanced trade.
