nal tax (note that the IS curve does not shift in a parallel fashion in this case) or when the exchange rate appreciates (it shifts in a parallel fashion in this case). The LM Curve. The LM shifts right when there is an increase in the money supply. The BP Curve. Fixed: The BP does not shift, regardless of the degree of capital mobility. The government must increase or decrease the money supply to counter any surplus or deficit in the Balance of Payments. Flexible: όPerfect: The BP does not shift (Capital flows overwhelm the change in the Current Account). The change in the exchange rate affects Net Exports and therefore the IS curve. όMobile: The change in the exchange rate affects NX, and therefore the Current Account. The IS and the BP both shift (in the same direction). όImmobile: Same as for mobile. Cases of Fiscal And Monetary Policies.Fixed Exchange Rates, Perfect Capital Mobility, Increase in Money SupplyThe increase in the Money supply shifts the LM curve to the right, the economy goes from point A to point B. At B, there are infinite capital outflows as domestic investors seek to purchase higher returning foreign assets. These investors are exchanging their unwanted dollars for foreign exchange. The Federal Reserve has agreed to maintain the exchange rate at e0, and therefore buys up the unwanted dollars and sells foreign exchange. As the Federal Reserve buys the dollars, the money supply is decreased: the LM curve moves to the left, coming to rest at its initial position. The economy moves back to A. There is no change in Y or I from this monetary policy. Moral: Monetary policy is ineffective in altering the level of domestic output under fixed exchange rates and perfect capital mobility.(Diagram 3, Appendix 1) Fixed Exchange Rates, Perfect Capital Mobility, Increase in G. The increase in G means an increase in Total Expenditures, therefore the IS curve shifts to the right and the economy goes from point A ...
