AEM_ECON_2300_Lecture_19___Spring_2009

AEM_ECON_2300_Lecture_19___Spring_2009 - Lecture 19...

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Lecture 19 1 of Professor David Lee AEM-ECON 2300 Alternative Views on Foreign Exchange Rate Determination Elasticity” approach Concern about inherent instability of foreign exchange rate Chronic trade deficits thought to lead to an inherent tendency toward currency depreciation. Problem “solved” by Marshall-Lerner condition for market stability: to improve a country’s trade balance, sum of elasticities of foreign demand for domestic currency (e.g., exports) and domestic demand for foreign currency (e.g., imports) must be > 1.0: ε X + ε M 1 A real devaluation will yield a stable outcome if Marshall- Lerner condition is met.
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Lecture 19 2 of Professor David Lee AEM-ECON 2300
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Lecture 19 3 of Professor David Lee AEM-ECON 2300 Alternative Views on Foreign Exchange Rate Determination Balance of payments or “absorption” approach Given: GNP = Y = C + I + G + (X – M) Net exports (“BOP”) = Y – C – I – G = Domestic money income – total domestic expenditures (“absorption”) • Approach recognizes that a country’s macroeconomic policies can have unequal effects on income and expenditures. A currency devaluation will improve a country’s trade balance only if national output increases relative to absorption. • Refocused interest on trade balance and on government policies which affect BOP. • Also focuses on “equilibrium exchange rate” – the exchange rate that reconciles national balances (unemployment and inflation) and external (current account) balance.
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Lecture 19 4 of Professor David Lee AEM-ECON 2300 Alternative Views on Foreign Exchange Rate Determination Monetarist approach
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This note was uploaded on 04/28/2009 for the course AEM 2300 taught by Professor Lee,d.r. during the Fall '06 term at Cornell.

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AEM_ECON_2300_Lecture_19___Spring_2009 - Lecture 19...

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