chapter 19 stuff

chapter 19 stuff - Chap 19 Macroeconomic policy goals in an...

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Chap 19 Macroeconomic policy goals in an open economy In open economies, policy makers are motivated by the goals of internal and external balance. “Internal balance” describes the macroeconomic goals of producing at potential output (at “full employment”) and of price stability (low inflation). An unsustainable use of resources (overemployment) tends to increase prices; an ineffective use of resources (underemployment) tends to decrease prices. Under and over employment lead to general price level movements that reduce the economy’s efficiency by making the real value of the monetary unit less certain and thus a less useful guide for economic decisions. Volatile aggregate demand and output tend to create volatile prices. Price level movements reduce the economy’s efficiency by making the real value of the monetary unit less certain and thus a less useful guide for economic decisions. To avoid price instability, government must prevent large fluctuations in output, which are also undesirable in themselves. In addition, it must avoid inflation and deflation by ensuring that the money supply does not grow too quickly or too slow. “External balance” is achieved when a current account is neither so deeply in deficit that the country may not be able to repay its foreign debts, nor so strongly in surplus that foreigners are put in that position. The goal of external balance is a level of the ca that allows the most important gains from trade over time to be realized without risking the problems discussed above. Because governments do not know this ca level exactly, they may try to avoid large deficits or surpluses unless there is clear evidence of large gains from intertemporal trade. Intertemporal trade is the trade of consumption over time. Countries with weak investment opportunities should invest little at home and channel their savings into more productive investment activity abroad (be net exporters and have current account surpluses) and countries relatively productive should be net importers of current output and have CA deficits. To pay off their foreign debt when the investments mature, the latter countries export output to the former countries and thereby complete the exchange of present output for future output. A large CA deficit caused by an expansionary fiscal policy that does not simultaneously make domestic investment opportunities more profitable may signal a need for the government to restore external balance by changing its economic course. Every economy faces an intertemporal budget constraint, which limits each country’s spending over time to levels that allows it to pay the interest and the principal on its foreign debts. Sometimes the external target is not imposed by the national government but external creditors as the government may have trouble meeting their payments on past foreign loans. This event is called a sudden stop in foreign lending. In this case governments may have to take severe action to reduce the country’s desired borrowing from
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chapter 19 stuff - Chap 19 Macroeconomic policy goals in an...

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