Lesson_70_Fiscal Policy with Fixed Exchange Rates

Lesson_70_Fiscal Policy with Fixed Exchange Rates - Fiscal...

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1 Lesson 70 1 Fiscal Policy with Fixed Exchange Rates We saw that the effective use of fiscal policy to influence economic activity was complicated when the exchange rate was permitted to float In this lesson, we show that fiscal policy can be quite effective when the job of the central bank is to maintain a fixed exchange rate Lesson 70 2 We begin by returning to the concept of external balance For our purposes, define external balance as a situation where the official settlements balance is zero: 00 CA NFA OFA += ⇒= Lesson 70 3 We’ve seen that this zero balance will not hold for any arbitrary exchange rate But we’ll show that we can adjust certain aspects of the economy so that this balance will hold (given the fixed exchange rate)
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2 Lesson 70 4 As an example, assume a currency (the peso) is pegged to the dollar at a value of 10 pesos per dollar and assume zero spread $ Q E 10 Lesson 70 5 External balance would require supply and demand for dollars to intersect exactly at an exchange rate of 10 pesos per dollar $ Q E 10 $ D $ S Lesson 70 6 Suppose they did not…e.g., suppose that they intersect at a 12 pesos per dollar $ Q E 10 $ D $ S $ D
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Lesson_70_Fiscal Policy with Fixed Exchange Rates - Fiscal...

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