chapter 12 - Chapter 12 The Mundell-Fleming Model...

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CHAPTER 12 Aggregate Demand in the Open Economy Aggregate Demand in the Open Economy slide 0 Chapter 12 Chapter 12 Aggregate Demand in the Aggregate Demand in the Open Economy Open Economy CHAPTER 12 Aggregate Demand in the Open Economy Aggregate Demand in the Open Economy slide 1 The The Mundell Mundell -Fleming Model Fleming Model ± Key assumption: Small open economy with perfect capital mobility. r = r* ± Goods market equilibrium---the IS* curve: () ( ) ( ) * Y CY T Ir G NXe = −+ ++ where e = nominal exchange rate CHAPTER 12 Aggregate Demand in the Open Economy slide 2 The The IS* IS* curve: Goods Market curve: Goods Market Eq’m Eq’m The curve is drawn for a given value of * . Intuition for the slope: IS ( ) ( ) * =− + + + eN XY ↓⇒ CHAPTER 12 Aggregate Demand in the Open Economy slide 3 The The LM* LM* curve: Money Market curve: Money Market Eq’m Eq’m The LM* curve ± is drawn for a given value of ± is vertical because: given , there is only one value of that equates money demand with supply, regardless of . LM (,) * MP Lr Y = CHAPTER 12 Aggregate Demand in the Open Economy slide 4 Equilibrium in the Mundell -Fleming model Fleming model * = ( ) ( ) * + + + equilibrium exchange rate equilibrium level of income CHAPTER 12 Aggregate Demand in the Open Economy slide 5 Floating & fixed exchange rates Floating & fixed exchange rates ± In a system of floating exchange rates , is allowed to fluctuate in response to changing economic conditions. ± In contrast, under fixed exchange rates , the central bank trades domestic for foreign currency at a predetermined price. ± We now consider fiscal, monetary, and trade policy: first in a floating exchange rate system, then in a fixed exchange rate system.
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CHAPTER 12 Aggregate Demand in the Open Economy Aggregate Demand in the Open Economy slide 6 Fiscal policy under floating exchange rates Y e (,) * MP Lr Y = () ( ) ( ) * CY T Ir G NXe =− + + + 1 1 1 * LM 1 * IS 2 * 2 At any given value of , a fiscal expansion increases , shifting IS* to the right. Results: > 0, = 0 CHAPTER 12 Aggregate Demand in the Open Economy Aggregate Demand in the Open Economy slide 7 Lessons about fiscal policy Lessons about fiscal policy ± In a small open economy with perfect capital mobility, fiscal policy is utterly incapable of affecting real GDP. ± “Crowding out” closed economy: Fiscal policy crowds out investment by causing the interest rate to rise. small open economy: Fiscal policy crowds out net exports by causing the exchange rate to appreciate. CHAPTER 12 Aggregate Demand in the Open Economy slide 8 Mon. policy under floating exchange rates * = ( ) ( ) * + + + 1 1 1 * 1 * 2 2 * 2 An increase in M shifts LM* right because must rise to restore eq’m in the money market.
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This note was uploaded on 09/18/2010 for the course ECON 1210 taught by Professor Mannigs.waters during the Fall '08 term at Broome Community College.

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chapter 12 - Chapter 12 The Mundell-Fleming Model...

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