BP curve

The BP curve which shows the interest rate and income levels for which the balance of payment is balanced (CA + CU = 0), is positively sloped. Raising Y creates more demand for imports and
worsens the current account.

For the BOP to be balanced this has to be offset by an improvement in the capital account. The latter will happen at a higher interest rate, as this attracts capital from abroad.

The slope of the BP line depends on the degree of capital mobility. The greater the capital mobility the flatter is the BP line i.e. the more sensitive capital movement is to differences in interest rate, the flatter is the capital account schedule and the flatter is the BP line. At one extreme, when there is perfect capital mobility (which requires that domestic and foreign assets be perfect substitutes), the BP line is horizontal and at the other extreme, when capital isperfectly immobile, the BP line is vertical since changes in the domestic interest rate will have no direct effect on the BOP.

A second factor that determines the slope of the BP line is the marginal propensity to import (m). The higher the marginal propensity to import the steeper is the BP line and vice versa.