Fixed Exchange Rates
(Figure 22.3)
Payments Adjustment for a Surplus Country

Initially, this economy is at point A. Point A is highlighted on the graph to the left. At point A, the IS and LM0 curves intersect. Point A is the the left of the FE curve, showing that the country has a surplus in its official settlements balance. In order to defend the fixed exchange rate, the money supply is increased. The increase in the money supply shifts the LM curve to the right. Click on the the Shift LM Curve button to show this change on the graph. Full adjustment will occur when point E has been reached. As a result of the change, interest rates will have fallen, domestic product will have risen, and the official settlements balance is zero since the economy is on the FE curve. Click the Show Changes button to show the changes in i and Y on the graph.
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