The IS* curve. Chapter 12: AD in Open Economy. Key assumption: Small open economy with perfect capital mobility. r = r*

Transcription

1 Chaptr : Th Mundll-Flming modl: -LM for th small opn conomy Causs and ffcts of intrst rat diffrntials Argumnts for fixd vs. floating xchang rats Th aggrgat dmand curv for th small opn conomy slid 0 Th Mundll-Flming Modl Ky assumption: Small opn conomy with prfct capital mobility. r = r Goods markt quilibrium---th curv: = C( T ) + I ( r ) + G + NX ( ) whr = nominal xchang rat = forign currncy pr unit of domstic currncy slid Th curv = C( T ) + I ( r ) + G + NX ( ) NX slid

2 NX() A wakr dollar (low ) incrass nt xports. In rcnt months th trnd in NX in th US has rvrsd (wak $) Blow: x: Euro-USD xchang rat y: changs in ral nt xports, slid 3 Th LM curv M P = L( r, ) LM slid 4 Equilibrium = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) LM slid 5

3 Floating & fixd xchang rats Floating xchang rats, is allowd to fluctuat in rspons to changing conomic conditions. Fixd xchang rats, th cntral bank trads domstic for forign currncy at a prdtrmind pric. W now considr fiscal, montary, and trad policy: first in a floating xchang rat systm, thn in a fixd xchang rat systm. slid 6 Fiscal policy undr flxibl = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) LM At any givn valu of, a fiscal xpansion incrass dmand, shifting to th right. slid 7 Lssons about fiscal policy In a small opn conomy with prfct capital mobility, fiscal policy dos not affct GDP Crowding out closd conomy: Fiscal policy crowds out invstmnt by causing th intrst rat to ris. small opn conomy: Fiscal policy crowds out nt xports by causing th xchang rat to apprciat. slid 8 3

4 Mon. policy undr flxibl = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) LM LM An incras in M shifts LM right bcaus must ris to rstor q m in th mony markt. slid 9 Lssons about montary policy Montary policy affcts output by affcting th componnts of aggrgat dmand: closd conomy: M r I small opn conomy: M NX Expansionary mon. policy shifts dmand from forign to domstic products. Thus, th incrass in incom and mploymnt at hom com at th xpns of losss abroad. slid 0 Trad policy undr floating xchang rats = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) At any givn valu of, a tariff or quota rducs imports, incrass NX, and shifts to th right. LM slid 4

5 Lssons about trad policy Import rstrictions cannot rduc a trad dficit. Evn though NX is unchangd, thr is lss trad: th trad rstriction rducs imports th xchang rat apprciation rducs xports Lss trad fwr gains from trad. Import rstrictions on spcific products sav jobs in th domstic industris that produc thos products, but dstroy jobs in xport-producing sctors. Import rstrictions crat sctoral shifts, which caus frictional unmploymnt. slid Fixd xchang rats CB stands rady to buy or sll th domstic currncy at a prdtrmind rat. CB shifts th LM curv as rquird to kp at its prannouncd rat. This systm fixs th nominal xchang rat. In th long run, whn prics ar flxibl, th ral xchang rat can mov vn if th nominal rat is fixd. slid 3 Fiscal policy undr fixd Undr floating rats, a fiscal xpansion would rais. LM LM To kp from rising, th cntral bank must sll domstic currncy, which incrass M and shifts LM right. slid 4 5

6 Montary policy undr fixd An incras in M would shift LM right and rduc. To prvnt th fall in, th cntral bank must buy domstic currncy, which rducs M and shifts LM back lft. LM LM slid 5 Trad policy undr fixd A rstriction on imports puts upward prssur on. To kp from rising, th cntral bank must sll domstic currncy, which incrass M and shifts LM right. LM LM slid 6 Diffrntials in th M-F M F modl r may diffr from r. Why? country risk: borrowrs might dfault on loan rpaymnts Lndrs rquir highr r to compnsat thm for this risk. xpctd xchang rat changs: E(Δ)<0 borrowrs must pay a highr r to compnsat lndrs for xpctd currncy dprciation. r = r + θ whr θ is a risk prmium. Substitut back into and LM quations: = C ( T ) + I ( r + θ ) + G + NX ( ) M P = L( r +θ, ) slid 7 6

7 Th ffcts of an incras in θ (flxibl) shifts lft θ r I LM shifts right θ r (M/P ) d, so must ris to rstor mony markt q m. LM LM slid 8 Th ffcts of an incras in θ Th fall in : domstic currncy lss attractiv. Th incras in :boost in NX (from th dprciation) gratr than th fall in I (from th ris in r ). BUT could not ris if: CB prvnts dprciation rducing M (qustion: what would happn undr fixd?) Dprciation boosts import prics so to incras th pric lvl (which would rduc th ral mony supply) Consumrs rspond to highr riskholding mor mony. slid 9 Floating vs. Fixd Exchang Rats Argumnt for floating rats: allows montary policy to b usd to pursu othr goals (stabl growth, low inflation) Argumnts for fixd rats: avoids uncrtainty and volatility, making intrnational transactions asir disciplins montary policy to prvnt xcssiv mony growth & hyprinflation slid 0 7

8 Which systm is bst? FIXED Prfrabl if shocks com from th mony markt (LM) FLEXIBLE Prfrabl if shocks com from th goods markt () or from abroad (r) Prfrabl if larg importr of xportr of primary products Prfrabl if borrowr from abroad. If prics mov slowly, lss costly to mov in rspons to shock that rquirs adjustmnt in th ral xchang rat. slid Th impossibl trinity Fr capital flows + Indpndnt montary policy Indpndnt montary policy + Fixd rats USA China Fixd xchang rat + Fr capital flows Hong Kong slid Mundll-Flming and th AD curv Prviously, w xamind th M-F modl with a fixd pric lvl. To driv th AD curv, considr impact of a chang in P in th M-F modl. W now writ th M-F quations as: ( ) = C( T ) + I ( r ) + G + NX ( ε ) ( LM ) M P = L( r, ) (Earlir, w could writ NX as a function of sinc and ε mov in sam dirction whn P is fixd.) slid 3 8

9 Driving th AD curv Why AD curv has ngativ slop: P (M/P ) LM shifts lft ε NX ε ε ε P P P LM(P ) LM(P ) AD slid 4 From th short run to th long run If <, thn thr is downward prssur on prics. Ovr tim, P will mov down, causing (M/P ) ε NX ε ε ε P LM(P ) LM(P ) P SRAS LRAS P SRAS AD slid 5 Larg: btwn small and closd Many countris - including th U.S. - ar nithr closd nor small opn conomis. A larg opn conomy is in btwn th polar cass of closd & small opn. Considr a montary xpansion: Lik in a closd conomy, ΔM > 0 r I (though not as much) Lik in a small opn conomy, ΔM > 0 ε NX (though not as much) slid 6 9