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S10 MyCh13 - Chapter 13 Open economy macro-economics...

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Chapter 13 Open economy macro-economics Motivation Exchange rate: concept and determination IS – LM analysis in the open economy Policy under the flexible exchange rate The fixed exchange rate & currency area 1
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Motivation In this Great Recession today the interconnectedness of the economic world is self-evident. American financial crisis has been transmitted to all economies Through the goods market [via the Current Account] ( the exchange rate channel ) - export market shrank for China; and the asset market [via the Capital Account] ( the interest rate channel ) - inward investment fell for India. Still another channel when European holdings of US MBS go bad 2
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3 Return to topics of Ch. 5, this time with some differences most economies have their own currencies: joining with each other by exchange rates , that can change. American economy is at the center in the world; American dollar is accepted as the ‘ vehicle currency ’, as the American trade is the life pulse to this world economy, American trade deficit is not (directly) at issue, in this crisis, though, in spite of the concern of Premier Putin at Davos.
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4 Chapter 5 depicts the world of the late 19 th Century when most important countries were on the gold standard , and the ‘gold content’ of paper money was the ‘exchange rate’. Any balance of payment crisis would drain an economy of money like a person threatened by a serious loss of blood, unless a country stops to honor payment abroad (in gold), but then all trade flow would stop, naturally . Or, all prices, wages (in gold) of a country would have to sink like a stone, whatever sense one can make of that.
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5 The world according to Ch. 5 is ‘unrealistic’ in another implicit but essential way: NX = Income minus Absorption = Y - (C + I + G). Every term on the right has the right to vary independently, but not the one located on the wrong side of = The net trade, NX. Obviously that is not right .
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6 Exchange rates The Nominal Exchange Rate Symbol: e nom Concept: e nom = How many foreign money does 1 home money worth?
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7 Exchange rate History Time Fixed Gold standard Before the Great Depression Bretton Woods Early post WWII Currency board Today for H K, etc. Flexible (floating) Present , officially Today, most places ‘Dirty float’
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8 The Impossible Trinity Convertible Currency Fixed exchange rate Independent $ policy USA PRC H K Does the central bank buy and sell indefinitely at a given rate?
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9 The Impossible Trinity Convertible Currency ( to ? ) Fixed exchange rate Independent $ policy USA PRC H K Does the central bank buy and sell indefinitely at a given rate?
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