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- Intermediate Macroeconomics Chapter 12 The Open Economy Revisited The Mundell-Fleming Model and the Exchange-Rate Regime Instructor Geoffrey

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Unformatted text preview: Intermediate Macroeconomics Chapter 12: The Open Economy Revisited The Mundell-Fleming Model and the Exchange-Rate Regime Instructor Geoffrey Williams Rutgers University June 18, 2009 Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited Outline Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited Overview Here we take the classical model of a small open economy (from Chapter 5) and add in the IS-LM ideas to create a new model for how trade affects an economy. Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited Small Open Economy As in Chapter 5 (and the midterm), we assume a small open economy . This means that the interest rate, r in our economy is determined by the worldwide market for loanable funds, and is equal to the world interest rate , r * . Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited Adding Trade to the IS Curve In chapter 10 we developed the IS Curve: Y = C ( Y- T ) + I ( r ) + G As noted, this is most of the National Income Accounts Identity, but not all of it We now add back Net Exports: Y = C ( Y- T ) + I ( r ) + G + NX ( e ) Notice that we base NX on e, not . This is because we are assuming fixed price levels p and p * , so any change in the nominal exchange rate is also a change in the real exchange rate. Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited Adding Trade to the IS Curve In chapter 10 we developed the IS Curve: Y = C ( Y- T ) + I ( r ) + G As noted, this is most of the National Income Accounts Identity, but not all of it We now add back Net Exports: Y = C ( Y- T ) + I ( r ) + G + NX ( e ) Notice that we base NX on e, not . This is because we are assuming fixed price levels p and p * , so any change in the nominal exchange rate is also a change in the real exchange rate. Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited The IS Curve vs the IS * Curve By adding in net exports, and fixing r = r * we have now switched from the IS curve to the IS * curve. Y = C ( Y- T ) + I ( r * ) + G + NX ( e ) In a small open economy in the short run, interest rates are exogenously set and so they are no longer the Y-axis of the IS-LM model. However, exchange rates (both nominal and real) are now endogenously set and so we include them in the IS-LM model. Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited The IS Curve Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited The IS* Curve Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited The IS* Curve in Action Instructor Geoffrey Williams Chapter 12: The Open Economy Revisited The LM Curve vs the LM * Curve As discussed in Chapter 10, the LM curve is: M / P = L ( r , Y ) Since we are assuming a fixed interest rate r * , set by the world markets, we can rewrite this as: M / P = L ( r * , Y ) What does this mean for the LM * Curve?...
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This note was uploaded on 02/29/2012 for the course 320 322 taught by Professor Macro-williams,micro-yoshi during the Fall '10 term at Rutgers.

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- Intermediate Macroeconomics Chapter 12 The Open Economy Revisited The Mundell-Fleming Model and the Exchange-Rate Regime Instructor Geoffrey

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