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What would happen to output and the interest rate in our open economy IS-LM if the...

What would happen to output and the interest rate in our open economy IS-LM if the U.S. imposed new regulations to restrict capital inflow?

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Answer #1

If new regulations are set in place to restrict the capital inflow in the economy, this will lead to lesser investments and thus leading to lesser output. In the IS-LM framework, LM curve is upward sloping whereas the IS curve is downward sloping. A restriction in investments will lead to a leftward shift in the IS curve from IS to IS' as shown in the diagram. The leftward shift will reduce the output from Y to Y' and a fall in market interest rate from i to i'. The equilibrium point will change from e to e' in the economy.

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