monecon.2018S.ch6.pdf - Chapter 6 Output and the Exchange Rate in the Short Run 6-1 Aim of Chapter model that explains the short-run behaviour of all

monecon.2018S.ch6.pdf - Chapter 6 Output and the Exchange...

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1 Chapter 6 Output and the Exchange Rate in the Short Run 6-2 Aim of Chapter? • model that explains the short-run behaviour of all important macroeconomic variables in an open economy = simultaneous equilibrium on asset and output markets => new in this Ch: SR model of output market => combination with our asset markets models • use this model - the DD-AA model - to study how government macroeconomic policies can affect output and the exchange rate ? from short-run to long-run, and back again ?
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2 6-3 My grand scheme of ER models © SHORT RUN LONG RUN (Ch 3) <fxm> R US = R EU + (E e - E)/ E R US , R EU exo E e exo (Ch 4) <mm> M s /P = L(R, Y) Y, P exo (Ch 5) <monetary approach> E USD/EUR = P US / P EU <asset approach> <general model> E USD/EUR = q USD/EUR * P US / P EU (Ch 6) <output> Y = D = C + I + G + CA Summary = DD-AA 6-4 What Determines a Country s Output Level? (p. 173) in the long run economy is at full employment (why?) domestic output depends only on available supplies of factors of production in the short run productive factors may be over/under-employed (why?) (shifts in) aggregate demand important conclusion determinants of output --> determinants of aggregate demand
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3 6-5 What Determines Aggregate Demand? ( p. 174) definition of aggregate demand = the amount of a country's goods and services demanded by households and firms throughout the world 6-6 What Determines Aggregate Demand? national income identity (from Ch. 2): closed economy Y = C + I + G open economy Y = C + I + G + EX – IM (2-1) Y = C + I + G + CA hence: aggregate demand is the sum of consumption demand (C) <-- investment demand (I) assumed given government demand (G) assumed given net export demand (CA) <--
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4 6-7 Determinants of C ( p. 174) determinants of consumption demand only disposable income Y d (= Y - T) (abstraction is made of real wealth, real interest rate, ...) + C = C (Y d ) 6-8 Determinants of CA ( p. 175-177) determinants of current account CA = CA (q, Y d ) where E = nominal exchange rate CA = CA (E*P * /P, Y d ) P* = foreign price level P = domestic price level note: EX and IM are measured in terms of domestic output !! cf. Y = C + I + G + EX - IM CA = EX - IM IM = EX * * (home basket/foreign basket) = EX * * (real exchange rate) = EX * * (EP * /P)
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5 6-9 Determinants of CA effect of increase in real exchange rate: q ? (= real depr.) impact on EX? home products cheaper relative to foreign => EX impact on IM? foreign products more expensive relative to domestic EX * * (real exchange rate)= IM ? domestic consumers each foreign product buy fewer units of is more expensive foreign products ( volume effect) ( value effect) overall impact on CA? for now: assume that volume effect > value affect => IM improvement of current account 6-10 Determinants of CA effect of increase in disposable income: Y d ? increases spending on all goods => IM EX = (why? ) worsening of the current account
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6 6-11 Table 6-1: Factors Determining the Current Account 6-12 6.2. The Equation of Aggregate Demand (p. 177) equation: D = C + I + G + CA D = C(Y d ) + I + G + CA(EP*/P, Y d ) D = C(Y-T) + I + G + CA(EP*/P, Y-T) D = D(EP*/P, Y-T, I, G) T, I, G given effect of increase in real exchange rate? (real
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