bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

458 MONETARY ECONOMICS
As indicated in Figure A3, it is normal to draw the BP curve for developed
countries as having a less steep slope than the LM curve, implying
that net capital inflow is significantly more interest elastic than the demand
for money. A BP curve for a less developed economy might, on the other
hand, be drawn more steeply sloped than the LM curve. Readers should
consider what this implies.
The final step with the BP curve is to consider what happens when the
exchange rate changes. A depreciation of the exchange rate (a fall in the
value of the domestic currency), ceteris paribus, increases a country’s
exports and reduces its imports resulting in an improvement in the current
account at every level of income. It follows that to maintain overall balance
in the balance of payments, there must be a matching capital outflow
and this only occurs if the domestic interest rate is lower at every level of
domestic income. In other words, the BP curve shifts down. Equally, an
exchange rate appreciation will push the BP curve up.