MACROECONOMICS-CH12

CHAPTER TWELVE Aggregate Demand in the Open Economy

Learning objectives ,[object Object],[object Object],[object Object],[object Object]

The Mundell-Fleming Model ,[object Object],[object Object],[object Object],where e = nominal exchange rate = foreign currency per unit of domestic currency

The IS* curve: Goods Market Eq’m ,[object Object],[object Object],Y e IS *

The LM* curve: Money Market Eq’m ,[object Object],[object Object],[object Object],Y e LM *

Equilibrium in the Mundell-Fleming model equilibrium exchange rate equilibrium level of income Y e LM * IS *

Floating & fixed exchange rates ,[object Object],[object Object],[object Object]

Fiscal policy under floating exchange rates ,[object Object],Y 1 Results:  e > 0,  Y = 0 Y e e 1 e 2

Lessons about fiscal policy ,[object Object],[object Object],[object Object],[object Object]

Mon. policy under floating exchange rates ,[object Object],Y 2 Results:  e < 0,  Y > 0 Y e e 1 Y 1 e 2

Lessons about monetary policy ,[object Object],[object Object],[object Object],[object Object],[object Object]

Trade policy under floating exchange rates ,[object Object],Results:  e > 0,  Y = 0 Y e e 1 Y 1 e 2

Lessons about trade policy ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Fixed exchange rates ,[object Object],[object Object],[object Object]

Fiscal policy under fixed exchange rates ,[object Object],Y 1 Results:  e = 0,  Y > 0 Y 2 To keep e from rising, the central bank must sell domestic currency, which increases M and shifts LM* right. Under floating rates, fiscal policy ineffective at changing output. Under fixed rates, fiscal policy is very effective at changing output. Y e e 1

Mon. policy under fixed exchange rates ,[object Object],To prevent the fall in e , the central bank must buy domestic currency, which reduces M and shifts LM* back left. Results:  e = 0,  Y = 0 Under floating rates, monetary policy is very effective at changing output. Under fixed rates, monetary policy cannot be used to affect output. Y e Y 1 e 1

Trade policy under fixed exchange rates ,[object Object],Results:  e = 0,  Y > 0 Y 2 To keep e from rising, the central bank must sell domestic currency, which increases M and shifts LM* right. Under floating rates, import restrictions do not affect Y or NX . Under fixed rates, import restrictions increase Y and NX . But, these gains come at the expense of other countries, as the policy merely shifts demand from foreign to domestic goods. Y e Y 1 e 1

M-F: summary of policy effects  0  0  0 import restriction 0 0 0    mon. expansion 0 0    0 fiscal expansion NX e Y NX e Y Policy impact on: fixed floating type of exchange rate regime:

Interest-rate differentials ,[object Object],[object Object],[object Object],[object Object]

Differentials in the M-F model ,[object Object],[object Object]

The effects of an increase in  ,[object Object],[object Object],LM* shifts right, because    r   ( M / P ) d , so Y must rise to restore money market eq’m. Results:  e < 0,  Y > 0 Y 2 Y e Y 1 e 1 e 2

[object Object],[object Object],[object Object],[object Object],[object Object],The effects of an increase in 

Why income might not rise ,[object Object],[object Object],[object Object],[object Object]

CASE STUDY: The Mexican Peso Crisis

The Peso Crisis didn’t just hurt Mexico ,[object Object],[object Object],[object Object],[object Object],[object Object]

Understanding the crisis ,[object Object],[object Object],[object Object],[object Object],[object Object]

Understanding the crisis ,[object Object],[object Object],[object Object],[object Object]

Dollar reserves of Mexico’s central bank ,[object Object],[object Object],[object Object],[object Object],During 1994, Mexico’s central bank hid the fact that its reserves were being depleted.

 the disaster  ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

The rescue package ,[object Object],[object Object],[object Object]

The S.E. Asian Crisis -1.2% (1996-97) -25.6% -48.3% Thailand -6.8% -43.8% -36.4% Malaysia -4.3% -18.2% -12.0% Japan -0.1% -36.0% -15.6% Singapore n.a. -19.7% -14.6% Taiwan 2.3% 2.7% n.a. U.S. -7.3% -21.9% -47.5% S. Korea -16.2% -32.6% -59.4% Indonesia nominal GDP % change 1997-98 stock market % change from 7/97 to 1/98 exchange rate % change from 7/97 to 1/98

Floating vs. Fixed Exchange Rates ,[object Object],[object Object],[object Object],[object Object],[object Object]

Mundell-Fleming and the AD curve ,[object Object],[object Object],(Earlier in this chapter, we could write NX as a function of e because e and  move in the same direction when P is fixed.)

Deriving the AD curve Y 1 Y 2 AD Y 2 Y 1 Why AD curve has negative slope:  P   ( M / P )  LM shifts left      NX   Y Y  Y P IS* LM* ( P 1 ) LM* ( P 2 ) P 1 P 2  2  1

From the short run to the long run then there is downward pressure on prices. Over time, P will move down, causing ( M / P )    NX  Y  LM* ( P 1 )  1  2 P 1 SRAS 1 Y  Y P IS* AD LRAS LM* ( P 2 ) P 2 SRAS 2

Large: between small and closed ,[object Object],[object Object],[object Object],[object Object],[object Object]

Chapter summary ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]

Chapter summary ,[object Object],[object Object],[object Object]

MACROECONOMICS-CH12

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