Page 220 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes possible points of intersection between the IS and LM schedules. The schedule IB need not
necessarily be a vertical line. Depending on the placement of the IS and LM schedules, it may
have a negative

IB

Zone II
Zone I Inflation and EB
Unemployment and BoP Surplus
)
(r BoP Surplus
Rate A C
Interest E

B
Zone III
Inflation and
BoP Deficit
Zone IV
Unemployment and D
BoP Deficit
O
Y
National Income (Y)

Figure 19.4: The Four Zones of Different Kinds of Internal and External Disequilibrium
slope or a positive slope. However, we proceed to analyse the conflicting results of different kinds of
monetary fiscal mix by assuming a vertical IB schedule. As shown in Figure 19.4, schedules IB and EB
intersect at point E. Point E is, therefore, the only point of simultaneous internal and external balance.
The points on schedule IB are the points of only internal equilibrium, and points on schedule EB are
the points of only external equilibrium. All other points in the diagram, e.g., points A, B, C and D, are
the point of both internal and external disequilibrium. The intersecting schedules IB and EB, divide
the diagram into four zones of internal and external disequilibrium. Each of these zones represents
different kinds of economic problem. The different kinds of economic problems associated with each
zone is listed below.
Zone I : Unemployment and BOP surplus
Zone II : Inflation and BOP surplus
Zone III : Inflation and BOP deficit
Zone IV : Unemployment and BOP deficit
An economy which is not operating at point E or at any point on the IB and EB schedules is operating
on a point in any of these four zones. From policy point of view, Zones I and III are the zones of
dilemma. The dilemma is that no uniform policy can be adopted if the economy is operating on any
two different points in any of these zones. For example, points A and B in Zone I need two different
combinations of monetary and fiscal policies. At point A the authorities are required to cut down the
government spending and to increase money supply in order to move towards point E. But, when
the economy is operating at point B, the authorities will be required to do the opposite. Similarly, two
opposite policies are required on points C and D in Zone III.
The situation is not as bad in Zones II and IV because, in these two zones, the direction of change in
at least the government spending is predictable. For example, in Zone II the authorities are required
to reduce the government spending irrespective of the point on which the economy is placed. Similarly,
in Zone IV, the government spending has to be increased on any point in the zone. But, the direction
of change in money supply remain uncertain as in case of Zones I and III.

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