Lesson_66_Monetary Policy with Flexible Exchange Rates

Lesson_66_Monetary Policy with Flexible Exchange Rates -...

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1 Lesson 66 1 Monetary Policy with Flexible Exchange Rates Suppose again that the economy is in an equilibrium with excessive unemployment Can monetary policy be used effectively to stimulate output? This lesson incorporates effect of monetary policy on exchange rate to answer this question Lesson 66 2 Start with IS-LM Y i 1 IS 1 LM 1 Y 1 i F Y Lesson 66 3 Expansionary monetary policy shifts LM to right Y i 1 IS 1 LM 1 Y 1 i F Y
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2 Lesson 66 4 If nothing else changed, would want to shift LM to point where it intersected IS and Y F Y i 1 LM 1 Y 1 i F Y 2 LM 1 IS Lesson 66 5 The resulting outcome would have lower interest rate Y i 1 LM 1 Y 1 i F Y 2 LM 2 i 1 IS Lesson 66 6 But the lower interest rate reduces attractiveness of dollar-denominated assets as a financial investment Demand for dollars falls, causing dollar to depreciate Assuming M-L is satisfied, current account improves…shifting IS to the right
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3 Lesson 66 7 The extra kick of the dollar’s depreciation raises output above full-employment and
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Lesson_66_Monetary Policy with Flexible Exchange Rates -...

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