Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol
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T.Y.B.A. Economics Paper - IV - Advanced Economic Theory (Eng)
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- Fiscal Policy
Output
i BP 0 IS 0 Y Interest rate LM E IS f i E expansion) do not change output. They simply lead to currency appreciation and thereby to an offsetting change in net exports. To begin with, it means an excess demand for that country‘s goods. That is, at the initial interest rate, exchange rate and output level the aggregate demand for goods exceeds the available supply. This indicates that a higher level or output is required for restoring equilibrium in the goods market. Therefore the IS curve shifts to the right from IS to IS'. The new intersection point must be E', at which the goods market and money market clear, at this point the level of output has risen and consequently the interest rate also has moved up (on account of a rise in demand for money caused by increase in income). But E' is not a equilibrium point because BOP is not in equilibrium. In fact the economy will not move to E' at all, because any tendency to move in that direction will be checked by an appreciation in the exchange rate and the economy will crawl back to the initial equilibrium point at E. The adjustment process that will be initiated by an in crease in world demand for the country‘s goods is as follows: To start with there is a tendency for output and income to increase. The increase in the demand for money induced by these changes will raise the domestic interest rate, which will as a result cease to be in alignment with this world interest rate. The resulting capital inflows will bring about an appreciation of the country‘s exchange rate and a consequent increase in imports and a decrease in exports. So the demand shifts away from domestic goods; the IS curve moves back to the original position (i.e., IS). It may be asked how far the appreciation of the exchange rate will proceed? This will continue so long as the domestic interest rate (i) exceeds the world interest rate (i f ) – until the IS schedule moves back to it original position. The inference is that under conditions of perfect capital mobility an expansion is exports have no lasting effect on equilibrium output. Fiscal Policy: Fiscal expansion is similar in its impact on the level of output to an increase in exports, because it too raises the level of aggregate demand. All the attendant consequences associated with an increase in exports follow: increase in interest rate, currency appreciation, fall in exports and increase in imports. In this case, complete ‗crowding out‘ takes place, but for a different reason. It is not because of a reduction in investment resulting from an increase in interest rate but because exchange appreciation reduce net exports. This situation may be contrasted with the effectiveness of fiscal expansion in raising equilibrium output under fixed exchange rate system. To repeat, under flexible exchange rate system with perfect capital mobility, real disturbances to demand do not affect equilibrium output. Download 1.59 Mb. Do'stlaringiz bilan baham: |
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