Notes on Analyzing Shocks with the International Finance Diagrams

The graphs referred to here can be found in “International Finance Slides.” The Powerpoint file Shocks that Can Shift Things in the International Finance Diagrams tells exactly how the curve shifts that gets the ball rolling. But then you need to know several things: 

  1. If either the CF(r) curve or the I(r) curve shifts, then the Demand for loanable funds curve (labeled "D") shifts in the same direction by the same horizontal amount. 

  2. The shift of the curve that gets the ball rolling has a bigger effect on that variable than the movement along the curve as r adjusts. (See “The Effects of Shifts in the CF(r) Curve on the Long-Run International Finance Diagram Are Not Ambiguous After All.” Also, apply this same kind of logic to shifts of the I(r) curve.)

  3. The quantity of CF determined up in the top three graphs also determines the location of the vertical Supply of $ curve. 

  4. Monetary policy has no effect on the long-run international finance diagram. Nothing on the graphs changes. 

  5. In the short run, monetary policy just changes r: basically, the central bank chooses r. In the short run, the horizontal line showing the r the central bank has chosen replaces the market for loanable funds curve. 

  6. Aggregate demand is determined by I + NX: that is it goes the same direction as I + NX    (unless a change in the C(Y) curve or in G got the ball rolling). 

  7. If the Fed is cancelling an effect on I + NX, it just needs to raise r if AD went up to make AD go back down or lower r if AD went down to make AD go back up. 

That is pretty much it. But you really do need to practice. It is really helpful to get together with a friend from the class to practice on this.