Macroeconomics by niusheng11

VIEWS: 4 PAGES: 26

									  Macroeconomics

       Lecture 14
Economic policy in the open
        economy
                 Outline
• Equilibrium in the three markets

• The logic of fixed exchange rates.

• Fiscal and monetary policy under perfect
  capital mobility.
    Equilibrium
e
             FE : R  R*

             IS : Y  c0  c1Yd  i0  i1R
                 G  CA(e; Y , Y )
                                 *



       IS*
               Y
       Equilibrium in the money
                market
                 MS
                     M D (Y , R)
                 P
Equilibrium in the foreign exchange market:   RR   *




     For given price level (P) and world interest
     rate (R*), the nominal stock of money (MS)
                     determines Y.
    R                        LM ( M S )

R  R1*
R  R0
       *
                                                  MS
                                                      M D (Y , R)
                                                  P


                                             Y
     e
                   *               *
           LM * (R0 , M S ) LM ( R , M S )
                                  1




                                                 MS 
                                                        LM * out
                                                 R* 


                                             Y
          Equilibrium I
e
     LM*(R*,M)            MS
                     LM :     M D (Y , R)
                          P
                    IS : Y  c0  c1Yd  i0  i1R
e0
                           G  CA(e)

                 IS*(R*,G)    FE : R  R*
                      Y
     Y0
      Equilibrium II
R
                              MS
          LM(MS)         LM :     M D (Y , R)
                              P
           Net inflow
                        IS : Y  c0  c1Yd  i0  i1R
R*              FE
          Net outflow       G  CA(e)

               IS(G,e)           FE : R  R*
                     Y
     Y0
      Exchange rate regimes

                      The central bank
Fixed exchange rate   committed to keep
                         e constant.


                       The exchange rate
Floating exchange     is determined at the
       rate             foreign exchange
                             market
Floating exchange rates                Fixed exchange rates

P   R*     Y*    G       MS            P    R*     Y*    G       e




    Y                R                     Y                 R



             e                                      MS
endogenous variables                    endogenous variables

 With perfect capital mobility the central bank (CB) cannot pursue an
 independent monetary policy (MS) under a fixed exchange rate regime.
The logic of a fixed exchange
rate regime in two different
           ways…
         An arbitrage argument
Suppose the market exchange rate = 2.
Suppose the fixed exchange rate = 1.

     Buy 1$ in the FOREX market:          ½£
                                                   ½£ in profits!
     Sell the 1$ to the central bank (CB): 1£


CB accumulates foreign reserves ($) AND gives out £ => the supply of
£ (domestic money) increases automatically bringing the market exchange
rate down to the fixed rate.
 e            LM * ( M 0 ) LM * ( M )         e
                                   1
                                                                              S0
                                                                                     S1

                    A                                       A
  e0                                          e0
                                                                C
                             C                e1
  e1
                                 IS * (G0 )                                 D0
                                     Y                                           £
                  Y0        Y1                          £0 £1
                                              R
 Monetary policy:
                                                                        LM ( M 0 )
                                                                           LM ( M 1 )
MS       R            outflow of capital
                                                   *   A            C
 depreciation e                              R                             FE
       CA             Y                                       B          IS (G0 , e1 )
                                                                         IS (G0 , e0 )
Floating exchange rate regime.                                                Y
                                                       Y0           Y1
            Monetary policy
• Floating exchange rates: new transmission
  mechanism (R=R*): MS increases => outflow of
  capital => depreciation of e => increase in CA.
• Fixed exchange rates: the exchange rate, e,
  effectively replaces MS as the policy instrument
  controlled by the central bank.
• Notice all this is for a fixed price level: Price
  effects make monetary policy ineffective in the
  long run (as usual..).
             What is next?


• Choice of exchange rate regime

• Exchange rate uncertainty and the EMS crisis.
                   Extra slides

           The central bank’s balance
                     sheet

Domestic
             Assets Liabilities    High-powered money
reserves      DR          H
Foreign       FR
reserves
                                  FR        H
           DR  FR = H                            multiplier

   M S  mDR  FR                         MS 

           money multiplier (see Begg et al. ch. 23.5)
             Extra slides
       Fixed exchange rate =>
       loss of control over MS
Exception: Sterilization     Short-run
   Suppose that MS is increased and depreciation
   pressure builds up.
 1) CB buys domestic currency in FOREX market
          MS 
 2) CB buys domestic bonds to private sector (OMO)
          MS 
Accumulation/deccummulation of foreign reserves.
                    Extra slides
           Comparison of the impact of an
             expansionary fiscal policy

               Y            CA            MS            e         R
  Fixed                                                      


Floating                                                      

 closed                                                        
economy


    increase a lot;      = increase;      = decrease;      = unchanged
     Comparison (expansionary) monetary and
        exchange rate (devaluation) policy

               Y            CA            MS            e         R
  Fixed                                                      


Floating                                                     

 closed
                                                               
economy


    increase a lot;      = increase;      = decrease;      = unchanged

								
To top