Table of Contents
Table of Contents
Surfing on the waves of the global economic crises, more precisely dealing with the escalating economic disturbances in the Euro zone, the economy of United Kingdom has suffered significant difficulties under the recession umbrella. Furthermore, given the flexible exchange rate system and a very high degree of international capital mobility within the economy, the government struggles to manipulate the monetary and fiscal policy, thus overcome the complexity and reach the desired, stable condition that currently is vaguely at sight. In order to clarify the outcome of policy changes, this work will demonstrate, more precisely depict the increase in money supply and government spending through the combination of IS/LM/BP modeling, followed by Phillips curve as well (Lui, 2011). Main Body
The model is depicted in figure 1. Vertical axis represents interest rate (i), whereas horizontal (Y) corresponds to output/income. IS curve is downward sloping thus represents the equilibrium in goods markets. According to Mishkin (2009) IS curve is downhill as it corresponds to the increase in the interest rate that leads to the decrease of overall output. Upward slopping curve (LM) depicts the equilibrium in Financial Markets, whereas the increase of income will be followed repeatedly with the growth of the interest rate. E represents the intersect of the equilibrium in financial markets (LM) and equilibrium in goods markets (IS). The IS-LM curves, more precisely their relationship if accepted well by the research add a significant value towards the demand for money, consumption information, certain equilibrium conditions as well as clarification investment reality (Ritter, 2008). According to Mishkin and Eakins (2011) observation of IS/LM model can contribute to the evaluation of central bank actions towards the money supply and government changes as tax regulation in the rather closed economy conditions (external factors do not account).
Figure 1 – IS/LM Model
Balance of Payments
In order to analyze the open economy, we need to take into account the balance of payments, more precisely examine the external balance of the economy. The horizontal BP line represents the equilibrium of transactions. Therefore, considering the situation when the equilibrium of transactions is not being 0, thus there is no presence of external equilibrium. If that was not the situation that would imply that the Central Bank would be losing reserves (bringing it closely, no Central Bank could allow itself to do that in the long time period) or it is going to acquire reserves (in the same way, a Central Bank is reluctant to pursue doing that, unless it strives to possess a current surplus that is likely to permit it to gain significant quantities of international assets). At the same time, the stratum of domestic interest rates has to be at the stratum of rates being present abroad to acquire external equilibrium. Figures over the BP will match a surplus, whilst the figures underneath the BP demonstrate a deficit. As could be seen in figure 2, BP is overlapped by the vertical illustration of the full-employment output level. Considering this situation, their overlap “E” is the point where at the same time internal and external equilibrium is accomplished (Darity et al, 2004). Figure 2 – IS/LM Model
In order to accurately analyze the IS-LM modeling within the open economy, along with the assumption of very high, perfect capital mobility, we need to access the Mundell – Fleming model. Therefore, Kneller (2007) implies that under the umbrella of perfect capital mobility a slight disturbance of the interest rate embraces an infinite capital flows. Equally important is that central bank is not in a position to undertake monetary policy that is independent within the fixed rate regime (Sliber, 1970). Increase in Money Supply
Figure 3 depicts the expansionary monetary...
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