Lecture 3 - EC 60 Lecture 16 Fixed Exchange Rates How does...

Info iconThis preview shows pages 1–8. Sign up to view the full content.

View Full Document Right Arrow Icon
EC 60: Lecture 16 Fixed Exchange Rates
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
How does the government fix  the exchange rate? The government announces that it will buy  and sell foreign exchange at the pegged  price. Suppose the euro is pegged at $1 = 1  €. The European Central Bank commits to  buy and sell euro in any amount for the  price of $1 per euro.
Background image of page 2
What does a peg mean for the  foreign exchange market? Start with the interest parity condition. Government announces that the exchange rate will not  change. So the US interest rate must be the same as the  European interest rate.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Money market equilibrium The interest rate is fixed. So the real money supply is fixed.
Background image of page 4
Let’s think through an increase in the money  supply. The economy starts at 0.   The central bank increases the money supply. Interest rates fall and the price of the dollar begins to fall. The Fed steps in and buys dollars.  The money supply returns to is original  level. L (R ,Y o ) R 0 0 1 E o E 1 R 1 0 1
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Monetary Expansion Under a fixed exchange rate regime,  monetary policy has no effect. Any increase in the money supply will  cause the interest to change. A fall in the interest rate will cause the  dollar to fall in price. The Treasury is forced to intervene,  buying dollars and selling euro. The U.S. money supply contracts.
Background image of page 6
expansion? An increase in G will shift the D schedule up.
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 8
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 24

Lecture 3 - EC 60 Lecture 16 Fixed Exchange Rates How does...

This preview shows document pages 1 - 8. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online