321LecNote13Ch12

321LecNote13Ch12 - Instructor : Kim, H.H. Fall 2009...

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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 1 Chapter 5. The Open Economy Revisited : The Mundell –Fleming Model and the Exchange Rate Regime In this chapter, you will learn: • the Mundell-Fleming model (IS-LM for the small open economy) • causes and effects of interest rate differentials • arguments for fixed vs. floating exchange rates • how to derive the aggregate demand curve for a small open economy The Mundell-Fleming model • Key assumption: Small open economy with perfect capital mobility. r = r* • Goods market equilibrium – the IS* curve: Where The IS* curve: Goods market eq’m The IS* curve is drawn for a given value of r*. Intuition for the slope: Y e
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 2 The LM* curve: Money market eq’m The LM* curve: • is drawn for a given value of r*. • is ___________ because: given r*, there is only one value of Y that equates money demand with supply, regardless of e. Equilibrium in the Mundell-Fleming model Floating & fixed exchange rates • In a system of floating exchange rates, e is allowed to __________ in response to changing economic conditions. • In contrast, under fixed exchange rates, the central bank trades domestic for foreign currency at a ________________________. • Next, policy analysis – – first, in a floating exchange rate system – then, in a fixed exchange rate system Y e
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 3 Fiscal policy under floating exchange rates At any given value of e, a fiscal expansion increases Y, __________________________________ Lessons about fiscal policy • In a small open economy with perfect capital mobility, fiscal policy _____________________ ________________________ • ___________________________ – closed economy: Fiscal policy ___________________________ by causing the ______________ to ________________. – small open economy: Fiscal policy ___________________________ by causing the ______________ to ________________. Y e LM * IS
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 4 Monetary policy under floating exchange rates An increase in M ________________ because Y must ______ to restore eq’m in the money market. Lessons about monetary policy • Monetary policy affects output by affecting the components of aggregate demand: closed economy: M r I Y small open economy: M e NX Y • Expansionary mon. policy ________________________________, it merely shifts demand from foreign to domestic products. So, the increases in domestic income and employment are _____________________________________. Y e LM * IS
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Instructor : Kim, H.H. Intermediate Macro Analysis Fall 2009 Economics 01:220:321 5 Trade policy under floating exchange rates At any given value of e, a tariff or quota __________________, ____________________________, and ______________________________. Lessons about trade policy • Import restrictions _________________________________ • Even though NX is unchanged, there is ______ trade: – the trade restriction _______________________ – the exchange rate appreciation _____________________ • Less trade means ____________________________ • Import restrictions on specific products save jobs in the domestic industries that produce those products, but destroy jobs in export-producing sectors.
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This note was uploaded on 02/07/2011 for the course ECON 321 taught by Professor Sani during the Fall '08 term at Rutgers.

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321LecNote13Ch12 - Instructor : Kim, H.H. Fall 2009...

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