Learning objectives. The Mundell-Fleming Model

Transcription

1 Larning objctivs 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 Aggrgat Dmand in th Opn Economy slid 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 Aggrgat Dmand in th Opn Economy slid

2 Th curv: Goods Markt Eq m = C( T ) + I ( r ) + G + NX ( ) Th curv is drawn for a givn valu of r. Intuition for th slop: NX Aggrgat Dmand in th Opn Economy slid 3 Th LM curv: Mony Markt Eq m Th LM curv is drawn for a givn valu of r is vrtical bcaus: givn r, thr is only on valu of that quats mony dmand with supply, rgardlss of. M P = L( r, ) LM Aggrgat Dmand in th Opn Economy slid 4

3 Equilibrium in th Mundll-Flming modl = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) LM quilibrium xchang rat quilibrium lvl of incom Aggrgat Dmand in th Opn Economy slid 5 Floating & fixd xchang rats In a systm of floating xchang rats, is allowd to fluctuat in rspons to changing conomic conditions. In contrast, undr 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. Aggrgat Dmand in th Opn Economy slid 6 3

4 Fiscal policy undr floating xchang rats = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) At any givn valu of, a fiscal xpansion incrass, shifting to th right. Rsults: Δ >, Δ = LM Aggrgat Dmand in th Opn Economy slid 7 Lssons about fiscal policy In a small opn conomy with prfct capital mobility, fiscal policy is uttrly incapabl of affcting ral 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. Aggrgat Dmand in th Opn Economy slid 8 4

5 Mon. policy undr floating xchang rats = C( T ) + I ( r ) + G + NX ( ) M P = L( r, ) An incras in M shifts LM right bcaus must ris to rstor q m in th mony markt. Rsults: Δ <, Δ > LM LM Aggrgat Dmand in th Opn Economy slid 9 Lssons about montary policy Montary policy affcts output by affcting on (or mor) of th componnts of aggrgat dmand: closd conomy: M r I small opn conomy: M NX Expansionary mon. policy dos not rais world aggrgat dmand, it shifts dmand from forign to domstic products. Thus, th incrass in incom and mploymnt at hom com at th xpns of losss abroad. Aggrgat Dmand in th Opn Economy slid 5

6 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. Rsults: Δ >, Δ = LM Aggrgat Dmand in th Opn Economy slid 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 mans 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. Hnc, import rstrictions fail to incras total mploymnt. Wors yt, import rstrictions crat sctoral shifts, which caus frictional unmploymnt. Aggrgat Dmand in th Opn Economy slid 6

7 Fixd xchang rats Undr a systm of fixd xchang rats, th country s cntral bank stands rady to buy or sll th domstic currncy for forign currncy at a prdtrmind rat. In th contxt of th Mundll- Flming modl, th cntral bank 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. Aggrgat Dmand in th Opn Economy slid 3 Fiscal policy undr fixd xchang rats Undr floating rats, a fiscal policy xpansion inffctiv would rais at changing. output. To Undr kp fixd from rats, rising, fiscal th cntral policy bank is vry must ffctiv sll domstic at changing currncy, output. which incrass M and shifts LM right. LM LM Rsults: Δ =, Δ > Aggrgat Dmand in th Opn Economy slid 4 7

8 Mon. policy undr fixd xchang rats An Undr incras floating rats, M would shift montary LM right policy and rduc is vry. ffctiv at changing To prvnt th fall in, output. th cntral bank must Undr buy domstic fixd rats, currncy, montary policy cannot b which rducs M and usd to affct output. shifts LM back lft. LM LM Rsults: Δ =, Δ = Aggrgat Dmand in th Opn Economy slid 5 Trad policy undr fixd xchang rats Undr A rstriction floating rats, on imports import puts rstrictions upward prssur do not affct on. or NX. LM LM Undr To kp fixd rats, from rising, import th cntral rstrictions bank must incras and NX. sll domstic currncy, But, which ths incrass gains com M at th and xpns shifts of LM othr right. countris, as th policy mrly Rsults: shifts dmand from forign Δ to = domstic, Δ goods. > Aggrgat Dmand in th Opn Economy slid 6 8

9 M-F: summary of policy ffcts typ of xchang rat rgim: floating fixd impact on: Policy NX NX fiscal xpansion mon. xpansion import rstriction Aggrgat Dmand in th Opn Economy slid 7 Intrst-rat rat diffrntials Two rasons why r may diffr from r country risk: Th risk that th country s borrowrs will dfault on thir loan rpaymnts bcaus of political or conomic turmoil. Lndrs rquir a highr intrst rat to compnsat thm for this risk. xpctd xchang rat changs: If a country s xchang rat is xpctd to fall, thn its borrowrs must pay a highr intrst rat to compnsat lndrs for th xpctd currncy dprciation. Aggrgat Dmand in th Opn Economy slid 8 9

10 Diffrntials in th M-F M F modl r = r + θ whr θ is a risk prmium. Substitut th xprssion for r into th and LM quations: = C( T ) + I ( r + θ ) + G + NX ( ) M P = L( r + θ, ) Aggrgat Dmand in th Opn Economy slid 9 Th ffcts of an incras in θ shifts lft, bcaus θ r I LM shifts right, bcaus θ r (M/P ) d, so must ris to rstor mony markt q m. Rsults: Δ <, Δ > LM LM Aggrgat Dmand in th Opn Economy slid

11 Th ffcts of an incras in θ Th fall in is intuitiv: An incras in country risk or an xpctd dprciation maks holding th country s currncy lss attractiv. Not: an xpctd dprciation is a slf-fulfilling prophcy. Th incras in occurs bcaus th boost in NX (from th dprciation) is vn gratr than th fall in I (from th ris in r ). Aggrgat Dmand in th Opn Economy slid Why incom might not ris Th cntral bank may try to prvnt th dprciation by rducing th mony supply Th dprciation might boost th pric of imports nough to incras th pric lvl (which would rduc th ral mony supply) Consumrs might rspond to th incrasd risk by holding mor mony. Each of th abov would shift LM lftward. Aggrgat Dmand in th Opn Economy slid

12 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 Aggrgat Dmand in th Opn Economy slid 3 Mundll-Flming and th AD curv Prviously, w xamind th M-F modl with a fixd pric lvl. To driv th AD curv, w now considr th 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 in this chaptr, w could writ NX as a function of bcaus and ε mov in th sam dirction whn P is fixd.) Aggrgat Dmand in th Opn Economy slid 33

13 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 Aggrgat Dmand in th Opn Economy slid 34 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 Aggrgat Dmand in th Opn Economy slid 35 3

14 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 > r I (though not as much) Lik in a small opn conomy, ΔM > ε NX (though not as much) Aggrgat Dmand in th Opn Economy slid 36 Chaptr summary. Mundll- Flming modl th - LM modl for a small opn conomy. taks P as givn can show how policis and shocks affct incom and th xchang rat. Fiscal policy affcts incom undr fixd xchang rats, but not undr floating xchang rats. Aggrgat Dmand in th Opn Economy slid 37 4

15 Chaptr summary 3. Montary policy affcts incom undr floating xchang rats. Undr fixd xchang rats, montary policy is not availabl to affct output. 4. Intrst rat diffrntials xist if invstors rquir a risk prmium to hold a country s assts. An incras in this risk prmium raiss domstic intrst rats and causs th country s xchang rat to dprciat. Aggrgat Dmand in th Opn Economy slid 38 Chaptr summary 5. Fixd vs. floating xchang rats Undr floating rats, montary policy is availabl for purposs othr than maintaining xchang rat stability. Fixd xchang rats rduc som of th uncrtainty in intrnational transactions. Aggrgat Dmand in th Opn Economy slid 39 5