Theory-Based Models
Theory-Based Models
Theory-Based Models
An open-economy extension of IS-LM adding the external balance condition to study fiscal policy, monetary policy, and capital mobility.
Theory-Based Models
An open-economy policy route showing how the domestic goods-money equilibrium sits relative to the balance-of-payments line.
Variables
Domestic output.
Domestic interest rate.
Rate-output combinations consistent with balance of payments equilibrium.
Assumptions
The BP line summarizes external financing conditions and capital mobility.
Steeper or flatter BP schedules stand in for lower or higher capital mobility.
Parameters
Demand independent of current output.
How much spending falls when the rate rises.
Money-market baseline rate.
Rate response to higher output in the money market.
External interest-rate anchor.
How external balance responds to domestic output.
Output anchor for the BP schedule.
Shock presets
Lowers the world-rate anchor and eases external financing.
Shifts IS outward.