Fixed Exchange Rates
(Figure 22.4)
Expansionary Monetary Policy

Initially, this economy is at point E. Point E is a triple intersection. An increase in the money supply would shift the LM curve to the right. Click the Shift LM Curve button to show this change on the graph. After the shift, the new IS-LM intersection is at point H. Point H is at the right of the FE curve. At point H, there is a payments deficit. To defend the fixed exchange rate, the country will intervene and the money supply will decrease. We can show the decrease in the money supply by shifting the LM curve back to the original triple intersection. Click the Shift LM Curve Back to show the change. From this graph, we can conclude that monetary policy will not be very effective because of the balance of payments feedback and the need to defend the fixed exchange rate.
Click continue when you are ready to go on to the next page.