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IS-LM and PJD (Demonstrated Interest Parity)
 Expansionary Fiscal PolicyThe policy shifts the IS curve to the right (IS1). Increases income and increases interest (r1 greater than r0 and y1 greater than y0). Higher interest rates appreciate the local currency (decrease of E) |  Contractionary Fiscal PolicyThe policy shifts the IS curve to the left. This generates a drop in interest rate and income. With lower interest rates, foreign investors do not have much incentive to invest in the country and leave. This decreases the value of the local currency (increases E). |  Expansionary Monetary policyThe policy shifts the LM curve to the right (LM1). Increases income and decreases interest (r1 less than r0 and y1 greater than y0). The lower interest rate depreciates the local currency (E1 above E0). |  Contractionary Monetary PolicyThe contractionary policy shifts the LM curve to the left (LM1). As a result, the interest rate increases. In this scenario, foreign investors see local currency bonds as a better investment. Therefore, the exchange rate decreases (ie, the local currency appreciates). |
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Subtitle:
IS = Equilibrium of the Real Market
LM = Financial Market Equilibrium
Y = GDP
r = Real Interest Rate
PJD = Demonstrated Interest Parity
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