Week_12_-_Open_Economy_Part_2

Week_12_-_Open_Economy_Part_2 - 1 ECMA06 Open Economy(Part...

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1 ECMA06 – Open Economy (Part 2) Open Economy (Part 2) Please complete the course evaluation on Intranet, I value your feedback! Outline A brief review of what we have learned for an open economy. Discuss the effectiveness of monetary and fiscal policies under flexible exchange rate. Discuss the effectiveness of monetary and fiscal policies under fixed exchange rate Wrap up the course!

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2 Open Economy – A Brief Review The AE Model in Generic Form – the Full Version Consumption: C = C 0 + c 1 DI, where DI = Y – T + TR Investment: I = I 0 – d(r – ) Government sector: G T = T 0 + t 1 Y TR = TR 0 – tr 1 Y Foreign sector: X = X 0 – x 1 (E – ) IM = IM 0 + im 1 Y + im 2 (E – ) The AE function: AE = C 0 + c 1 [Y – (T 0 + t 1 Y) + (TR 0 – tr 1 Y )] + [I 0 – d(r– )] + G + [X 0 – x 1 (E – )] – [IM 0 + im 1 Y + im 2 (E – )] AE = C 0 + I 0 + G + X 0 – IM 0 – c 1 T 0 + c 1 TR 0 – d(r –) – (x 1 + im 2 )(E – ) + [c 1 (1 – t 1 – tr 1 ) – im 1 ]Y AE = AE 0 + c Y Y, where AE 0 = C 0 + I 0 + G + X 0 – IM 0 – c 1 T 0 + c 1 TR 0 – d(r –) – (x 1 + im 2 )(E – ) c Y = c 1 (1 – t 1 – tr 1 ) – im 1 Equilibrium level of output (equating Y = AE): Y* = AE 0 × Observations
3 ECMA06 – Open Economy (Part 2) Holding all else constant, in E in exports & in imports in AE 0 ⇒∆ in Y. When C\$ appreciates (E ), Canadian goods become more expensive X & IM AE Y . A change in interest rate has two effects on the economy: 1) It affects the cost of borrowing and then investment. r cost of borrowing I Y . 2)

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Week_12_-_Open_Economy_Part_2 - 1 ECMA06 Open Economy(Part...

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