Chap025

Chap025 - Chapter 25 Economic Policy in the Open Economy...

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Chapter 25 – Economic Policy in the Open Economy Under Fixed Exchange Rates CHAPTER 25 ECONOMIC POLICY IN THE OPEN ECONOMY UNDER FIXED EXCHANGE RATES Learning Objectives: To understand general equilibrium in the macroeconomy using the IS/LM/BP model. To grasp the impact of changes in fiscal policy on income, trade, and interest rates under fixed exchange rates. To grasp the impact of changes in monetary policy on income, trade, and interest rates under fixed exchange rates. To perceive how varying degrees of capital mobility alter the effectiveness of fiscal and monetary policy under a system of fixed exchange rates. I. Outline Introduction - The Case of the Chinese Renminbi Yuan Targets, Instruments, and Economic Policy in a Two-Instrument, Two-Target Model General Equilibrium in the Open Economy: The IS/LM/BP Model - General Equilibrium in the Money Market: The LM Curve - General Equilibrium in the Real Sector: The IS Curve - Simultaneous Equilibrium in the Monetary and Real Sectors - Equilibrium in the Balance of Payments: The BP Curve - Equilibrium in the Open Economy: The Simultaneous Use of the LM, IS, and BP Curves The Effects of Fiscal Policy under Fixed Exchange Rates The Effects of Monetary Policy under Fixed Exchange Rates The Effect of Official Changes in the Exchange Rate Summary II. Special Chapter Features In The Real World: Exchange Rate Arrangements Titans of International Economics: Robert A. Mundell (born 1932) In The Real World: The Presence of Exchange Controls in the Current Financial System In The Real World: The Rise and Fall of a Currency Board – The Case of Argentina 25-1
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Chapter 25 – Economic Policy in the Open Economy Under Fixed Exchange Rates III. Purpose of Chapter The purpose of the chapter is to develop the IS/LM/BP analysis and then to show how domestic macroeconomic policy influences the open economy under a system of fixed exchange rates. The policy material focuses on the impacts of monetary policy, fiscal policy, and expenditure-switching policies under different degrees of international capital mobility. IV. Teaching Tips A. In recent years various news sources have emphasized that the Chinese renminbi yuan has been pegged to the U.S. dollar since 1994 and that the Chinese trade surplus with the United States has grown steadily over this time. This has led to considerable pressure on the Chinese to revalue (appreciate) their currency to reduce this trade imbalance. (In fact, since 2005, the Chinese have allowed the yuan to appreciate very slightly against the dollar.) This chapter’s opening vignette points out that there are indeed different opinions on the need or desirability of this policy action by China and that such action can have far-reaching effects. This case can be used to generate interest in the policy implications of a fixed exchange rate in the open economy.
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Chap025 - Chapter 25 Economic Policy in the Open Economy...

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