Chapter_19 - Chapter 19 Macroeconomic Policy and...

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Chapter 19: Macroeconomic Policy and Coordination under Floating Exchange Rate The Case for Floating (Flexible) Exchange Rates 1) Monetary Policy Autonomy By removing the obligations of the central bank to maintain the fixed exchange rate, it allows the country’s central bank to use monetary policy to stabilize the economy. Chapter 17: Monetary policy is ineffective under fixed exchange rate (i.e., changes in MS cannot affect output in the short run). Chapter 16: Monetary policy is effective under flexible exchange rate (i.e., MS can be used to smooth out business cycles). Country no longer has to “import” foreign monetary policy. Thus, country is free to choose its desired long-run inflation rate. RPPP: * π - π E E E e = - Fixed exchange rate: E e = E π = π *. Flexible exchange rate: E e does not necessary equal to E π π *. ECMC61 – Chapter 19 1
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2) Exchange Rates as Automatic Stabilizers Flexible exchange rates allow less painful adjustment when the shocks originated from the goods/output market . Suppose autonomous consumption decreases temporarily: E DD(C 0 ) A E 0 AA(MS 0 ) Y The Case Against Floating (Flexible) Exchange Rates 1) Discipline Since the government does not need to worry about the country’s stock of official reserves, the economy may run into the danger of adopting over-expansionary
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This note was uploaded on 02/05/2011 for the course ECM 61 taught by Professor Jackparkinson during the Summer '10 term at University of Toronto.

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Chapter_19 - Chapter 19 Macroeconomic Policy and...

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