6 in fact we should see the currency appreciate to

This preview shows 9 out of 16 pages.

6. In fact, we should see the currency appreciate to its new long-run value. This apprecia- tion lowers net export demand just enough to o/set the higher demand coming from the government. This leaves output at its long-run level. 9
Image of page 9

Subscribe to view the full document.

Macroeconomic policies and the current account ° To determine the e/ect of monetary and ²scal policies on the current account, combine AA and DD curves with the XX curve ° XX curve represents the combinations of output and exchange rates at which the current account is at its desired level, say CA ( EP ± =P; Y ² T ) = X ° As income from production increases, imports increase and the current account decreases when other factors remain constant ° To keep the current account at its desired level, the domestic currency must depreciate as income from production increases ° = ) the XX curve slopes upward 10
Image of page 10
XX schedule ° The XX curve slopes upward but is ±atter than the DD curve. Why? 11
Image of page 11

Subscribe to view the full document.

XX schedule ° Consider how CA changes as we move to point 2 on the DD curve: As Y " , domestic demand for domestic output rises by less than the rise in Y: This is because part of the output is saved and part is spent on imports (thus reducing CA ). ° To prevent excess supply of home output, E must rise to make export demand rise faster than imports. In other words, net foreign demand (CA) must rise su¢ ciently along the DD curve as Y rises to cover up the slack left by domestic savings. ° As domestic income and production increase, the domestic currency must depreciate to entice foreigners to increase their demand of domestic products in order to keep the current account (only one component of aggregate demand) at its desired level³ on the XX curve. ° As domestic income and production increase, the domestic currency must depreciate more rapidly to entice foreigners to increase their demand of domestic products in order to keep aggregate demand (by domestic residents and foreigners) equal to production³ on the DD curve. ° Thus to the right of point 1, DD is above XX; where CA > X: ° Similarly, to the left of point 1, DD is below the XX curve (where CA < X ) : 12
Image of page 12
Macroeconomic Policies and the Current Account ° Policies a/ect the current account through their in±uence on the value of the domestic currency. 13
Image of page 13

Subscribe to view the full document.

Macroeconomic Policies and the Current Account ° An increase in M s depreciates the domestic currency and increases the current account in the short run ° " M s shifts the economy to a position like point 2 ° point 2 lies above XX curve, so that CA improves following policy action. ° An increase in G or decrease in T appreciates the domestic currency and often decreases the current account in the short run ° " G (which is temporary ) shifts the economy to a position like point 3, so there is deterioration in CA ° " G (which is permanent ) shifts the economy to a position like point 4, so there is an even larger deterioration in CA: 14
Image of page 14
Gradual adjustment to CA ° An important assumption underlying AA ² DD model is that changes in RER have im- mediate e/ect on the CA: ° In reality, the behavior of trade ±ows is more complex, and results in much more gradual adjustments in the CA: ° J-curve:
Image of page 15

Subscribe to view the full document.

Image of page 16
You've reached the end of this preview.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern