P. Monetary policy - flexible exchange rates The economy of a small country, Cascadia, under a flexible exchange rate regime, is on an IS-LM- BP intersection. We start with a position where the BP, CA and FA are all balanced. Cascadia trades a lot with the rest of the world but allows only limited access to its capital market while its citizens need authorizations to invest abroad. Cascadia is concerned by a sharp increase in the price of oil, oil being an important component in the CPI. If you were the president of the central bank, what would you do to deal with this situation? a. Spell out the policy carried out by the central bank (be specific) b. Use the graph below showing the IS-LM to illustrate the impact of the policy - name the starting equilibrium point a. Draw the BP curve. Show the shifts (if any) of the 3 curves IS-LM-BP resulting from the policy adopted. Break down the effect into two stages: i. name the impact of the policy alone point b ii. name the final equilibrium point c LM IS Y c. i. What is the status of the current account in b (compared to a)? CA<0 ca>0 Why? ii. What is the status of the financial account in b? FA<0 fa>0 Why? iii. What is the status of the balance of payments in b? BP<0 bp>0 iv. What will be the impact on the exchange rate? Appreciates Stays the same Depreciates 3 ECON 472 Name: Autumn 2020 v. What will eventually happen to income in c - compared to its initial position in a? Increases Stays the same Decreases d. If the Central Bank did not want to deal with this issue, do you think the government could do much to try to alleviate the impact of the rising prices of oil on the CPI