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Chap 12
Chap 12
CHAPTER
N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
In this chapter, you will learn…
Key assumption:
Small open economy with perfect capital mobility.
r = r*
Goods market equilibrium – the IS* curve:
Y C (Y T ) I (r *) G NX (e )
where
e = nominal exchange rate
= foreign currency per unit domestic currency
IS*
Y
equilibrium
exchange
rate
IS*
equilibrium Y
level of
income
CHAPTER 12 The Open Economy Revisited slide 6
Floating & fixed exchange rates
Under
Underfloating
Under floating
floating rates,
rates,
rates,
afiscal
fiscalpolicy
fiscal expansion
policy is
is ineffective
ineffective e LM 1*LM 2*
would
at raise e.output.
at changing
changing output.
To keepfixed
Under e from rising,
rates,
Under fixed rates,
the central bank
fiscal must
fiscal policy
policy is
is very
very
sell domesticchanging
currency, e1
effective
effective atat changing
which
output.increases M IS 2*
output.
and shifts LM* right. IS 1*
Results: Y
Y1 Y2
e = 0, Y > 0
CHAPTER 12 The Open Economy Revisited slide 16
Monetary policy under fixed
exchange rates
An increase
Under
Under in Mrates,
floating
floating would
rates,
monetary
shift policy
LM* right
monetary andis
policy isreduce e.
e LM 1*LM 2*
very
very
To effective
effective
prevent at
at in e,
the fall
changing
the central output.
changing output.
bank must
buy
Under
Underdomestic
fixed currency,
fixed rates,
rates,
which reduces
monetary
monetary M and
policy
policy cannot
cannot e1
shifts
be LM*to
be used
used back
to left.output.
affect
affect output.
Results: IS 1*
Y
e = 0, Y = 0 Y1
Policy Y e NX Y e NX
fiscal expansion 0 0 0
mon. expansion 0 0 0
import restriction 0 0 0
30
25
20
15
10
7/10/94 8/29/94 10/18/94 12/7/94 1/26/95 3/17/95 5/6/95
30
25
20
15
10
7/10/94 8/29/94 10/18/94 12/7/94 1/26/95 3/17/95 5/6/95
December
December1993
1993………………
……………… $28
$28billion
billion
August
August17,
17,1994
1994………………
………………$17
$17billion
billion
December
December1,
1,1994
1994……………
……………$$99billion
billion
December
December15,
15,1994
1994…………
………… $$77billion
billion
(LM* ) M P L (r *,Y )
(Earlier in this chapter, P was fixed, so we
could write NX as a function of e instead of .)
CHAPTER 12 The Open Economy Revisited slide 40
Deriving the AD curve
LM*(P2) LM*(P1)
Why AD curve has
2
negative slope:
1
P (M/P)
IS*
LM shifts left Y2 Y1 Y
P
P2
NX P1
Y AD
Y2 Y1 Y
1. Mundell-Fleming model
the IS-LM model for a small open economy.
takes P as given.
can show how policies and shocks affect income
and the exchange rate.
2. Fiscal policy
affects income under fixed exchange rates, but not
under floating exchange rates.
3. Monetary policy
affects income under floating exchange rates.
under fixed exchange rates, monetary policy is not
available to affect output.
4. Interest rate differentials
exist if investors require a risk premium to hold a
country’s assets.
An increase in this risk premium raises domestic
interest rates and causes the country’s exchange
rate to depreciate.