Lec22-_Ch20-II_-ECON2123-LI-fa13-stu

The second effect which is present only in the open

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Unformatted text preview: the open economy, is the effect through the exchange rate. 6 3 GOODS AND FINANCIAL MARKETS TOGETHER (20-3) Figure 20 – 2 The IS–LM Model in an Open Economy An increase in the interest rate reduces output both directly and indirectly (through the exchange rate): The IS curve is downward sloping. Given the real money stock, an increase in output increases the interest rate: The LM curve is upward sloping. 7 4 EFFECTS OF POLICY IN OPEN ECONOMY 4-1 UNDER FLEXIBLE EXCHANGE RATE REGIME (20-4) (1) The Effects of Fiscal Policy in an Open Economy Figure 20 – 3 The Effects of an Increase in Government Spending An increase in government spending leads to an increase in output, an increase in the interest rate, and an appreciation. The increase in government spending shifts the IS curve to the right. It shifts neither the LM curve nor the interest-parity curve. 4-1 THE EFFECTS OF POLICY IN AN OPEN ECONOMY (20-4) (1) The Effects of Fiscal Policy in an Open Economy Can we tell what happens to the various components of demand for money when the government increases spending: Consumption and government spending both go up. The effect of government spending on investment was ambiguous in the closed economy, it remains ambiguous in the open economy. Both the increase in output and the appreciation combine to decrease net exports. Budget deficit + trade deficit twin deficit 4-1 THE EFFECTS OF POLICY IN AN OPEN ECONOMY (20-4) (2) The Effects of Monetary Policy in an Open Economy Figure 20 – 4 The Effects of a Monetary Contraction A monetary contraction leads to a decrease in output, an increase in the interest rate, and an appreciation. A monetary contraction shifts the LM curve up. It shifts neither the IS curve nor the interest-parity curve. 4 EFFECTS OF POLICY IN OPEN ECONOMY 4-2 UNDER FIXED EXCHANGE RATE REGIME (20-5) Central banks act under implicit and explicit exchange-rate targets and use monetary policy to achieve those targets. Some countries operate under fixed exchange ra...
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