Derivation of Expansionary Monetary Policy (With Diagram)

Impact of an Expansionary Monetary Policy:

Money supply will increase.

LM curve shifts to the right.

Income level will increase.

r will fall.

.^.. r < r*

.^.. Investors will invest abroad

CF will rise; ER will fall; NX will increase.

Impact of monetary expansion:

Money supply increases

When r falls (r < r*)

CF rises from CF₁ to CF₂ (Fig. 17.8(b))

Reason:

Investment abroad increases

When CF rises

ER depreciates from є₁ to є₂

NX rises from NX₁ to NX₂ (Fig. 17.8 (c))

(because of inverse relation between NX and ER)