{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

CH20 - 20 AND INTERDEPENDENCE FOCUSOFTHECHAPTER Thischapter...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
20 I NTERNATIONAL  A DJUSTMENT   AND  I NTERDEPENDENCE FOCUS OF THE CHAPTER • This chapter  extends  the open  economy  analysis of Chapter  12 by allowing  the domestic price   level to change.  Methods  and  strategies of foreign  exchange  intervention  are explored  in   greater depth. SECTION SUMMARIES 1. Adjustment Under Fixed Exchange Rates In our discussion  of fixed exchange  rate regimes in Chapter  12 we assumed  that the central bank   would  take preventative action to insure that balance-of-payments  problems  never occurred.   In   reality, this is a little idealistic.  Central banks  can, and  do, finance temporary  payments   imbalances.  This section asks what  happens  when  one of these imbalances proves less   temporary  than  the central bank  had  hoped.    In order to finance a payments  imbalance, a central bank  must  regularly  intervene  in the   currency  market, buying  or selling foreign exchange.  In a balance-of-payments  deficit, the   demand  for foreign  currency  exceeds the supply  and  the central bank  must  step in regularly to   make up  the difference.  It is limited  by its reserves and  cannot  keep  this up  forever; ultimately it  must  devalue  its currency.  But if it chooses not to do this there is an automatic adjustment   process that takes effect:  the decline in the central bank’s reserves caused  by its currency  market   intervention  gradually  erode  the stock of high-powered  money  and  reduce aggregate  demand.   As long as the central bank  does not try to offset this by buying  domestic bonds  ( sterilizing  its  intervention) this will eventually  repair the payments  imbalance.  If the payments  imbalance   occurs with  output  at or below  potential output,  a decline in wages and  prices may  also have to   occur to bring the economy  back into internal balance.  This will reduce the real exchange  rate   (remember  it’s the nominal  exchange  rate that’s fixed) and  add  a bit back to aggregate  demand   by raising net exports.  This slow return  to internal and  external balance is called the  classical   adjustment  process . 216
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
217 C HAPTER  20 A combination  of  expenditure switching policies policies which  shift demand  between   domestically produced  goods  and  goods  produced  in other countries and   expenditure reducing   (or expenditure increasing) policies policies which  decrease (or increase) aggregate   demand can achieve internal and  external balance both more quickly and  with  much  less pain   than  the classical adjustment  process.  We have already  observed  that devaluation  could  have  
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}