Answer to Question #184045 in Macroeconomics for Keitumetse

Question

In the U.S., President Biden recently approved a $1.9 trillion stimulus package aimed at getting the 

economy going. U.S. workers who earned less than $ 75 000 a year in 2019 each received a $ 1 400 

stimulus check over the past few weeks. 

Use the IS-LM-BP model to explain what this can mean for the levels of output/income and interest 

rates in South Africa. Draw the graph and explain the complete chain reaction.

Answer 1

This is a stimulated fiscal policy through increased government spending

Let's assume that a stimulating fiscal policy is being implemented through increased government spending. At a given interest rate, the demand in the commodity market will increase, and the IS curve will shift to the right, as shown in the figure

In a closed economy, such fiscal policy would lead to a new equilibrium at point B (at the intersection of the new IS1 curve with the original LM curve). However, in an open economy, a new equilibrium will be established at the point C lying on the line BP (where i* = i). Let's explain how this happens. Households at the new equilibrium (at point B, with an increased national interest rate compared to the world rate) will increase their speculative demand for money and to meet it will convert foreign assets into the national currency, so that the money supply will endogenously increase from LM to LM1. Foreign capital is attracted to the economy by an increased interest rate (i1).

Thus, there is a surplus of foreign currency in the economy, which gives an impulse to increase the exchange rate.