Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Capitolo 10
Domanda Aggregata, Prodotto, e Tasso di Interesse
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Cyclical fluctuations
Figure 10.01
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Time
Rea
l GD
P
0
Long-term growth trend
Changes we see
Actual real GDP
, and how we decompose them.
(-) cyclical deviation
(+) cyclical deviation
Figure 10.01
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Table 10.01
Openness and size (%)Share of world
GDPOpenness
Poland 0.6 29.7Belgium 0.8 80.3Sweden 0.7 40.2
Switzerland 0.8 40.9Netherlands 1.3 59.1Korea, Rep. 1.5 39.3
Brazil 1.4 14.7Canada 2.2 14.7China 3.9 27.4
United Kingdom 4.8 26.7Germany 6.1 33.5Japan 12.4 10.5
European Monetary Union 20.6 11.1United States 32.1 11.8
Source: World Development Indicators , The World Bank, 2004
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
General macroeconomic equilibriumin the open economy
Figure 10.02
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Interaction of markets in the closed economy
GoodsMarket
MoneyMarket
Interest rates affect aggregate demand
Income influences demand for money
Figure 10.02
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Now we open the economy…
GoodsMarket
MoneyMarket
ForeignExchange
Market
Real exchange rates affect aggregate demand
Interest ratesinfluence
the exchange rate
Interest rates affect aggregate demand
Income influences demand for money
Figure 10.02
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
♦ Identità contabile fondamentale (equazione delle risorse-impieghi)
Y = C + I + G + XZ
C = C(, Y-T), con e T dati o esogeni (* e T*)
I = I(i, q), q esogeno (animal spirits), q*
G esogena G*
SPPC =X-Z=SPPC(Y, Y*, ), Y* reddito estero
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
♦ Parità dei tassi di interesse: i* = i♦ ius=ie
♦ (1+ius)=(1/St)(1+ie)St+1=(1+ie) St+1/St
♦ St+1=(1+s) St
♦ (1+ius)=(1+ie)(1+s) se prendo i log (approssim.)♦ ius=ie+s dove s è la variazione del tasso di cambio
nominale♦ se ius>ie per garantire lo stesso rendimento delle
attività nei due paesi s>0 (apprezzamento dell’euro), ma ciò implica anche che all’inizio (quando si verifica ius>ie) l’euro si deve svalutare
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
The 45° diagram
Figure 10.03
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Output
Des
ired
dem
and
DD
0
*, , , ,C T I i q G CA YP YDD Y
varies
Figure 10.03
varies
Ceteris paribus
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Equilibrium conditionD
esire
d de
man
d
0
45°
equilibrium inthe goods market i.e. =0 Y
DD Y
excess supply of goods
DD Y
0Y
Figure 10.03
Output
DD
Y´Y
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
The 45° Diagram, a.k.a. “The Keynesian Cross”D
esire
d de
man
d
0
45°
DD
Y
Y
*
, ,
, ,
Y C Y T I i q
G PCA Y Y
A
Figure 10.03
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
The multiplier
Figure 10.04
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Start from an equilibrium in the goods marketD
esire
d de
man
d
Y
DD
45°
DD(Y)
A
Figure 10.04
Output0
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006 Output
Des
ired
dem
and
Y
45°
DD´(Y)
ADD
DD(Y)
*
´
´ , , , ,
G
DD C Y T I i q G G PCA Y Y
Government expenditures increase
Figure 10.04
Output0
G
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
B
Output increases to match increase in demand
Output
Des
ired
dem
and
A
Y
Y
45°
A´ DD(Y)
DD´(Y)
Figure 10.04
Output0
G
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
BA´ increase in income means DD´ increases too
Output
Des
ired
dem
and
A
Y
Y
45°
BB´
DD(Y)
DD´(Y)
Figure 10.04
Output0
G
A´
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
A´´
Output increases againto meet induced demand, A´B´
Output
Des
ired
dem
and
Y
Y
45°
BA´
B´
DD(Y)
DD´(Y)
A
Figure 10.04
Output0
G
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
A´´
The government spending multiplier
Output
Des
ired
dem
and
A
Y
Y
45°
BA´
E
Y*
Y
B´
DD(Y)
DD´(Y)
Y G
Figure 10.04
Output0
G
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Years after change
1 2 3
Euro Area 1.43 1.31 0.41
UK 0.75 0.33 0.01
USA 1.05 0.49 -0.38
Canada 1.24 0.52 -0.17
Japan 1.85 1.58 -0.09
Demand Multipliers: Five Examples
The numbers represent the effect of a change in government expenditure of 1% of real GDP in 2000 and 2001 in all five regions on each economy's output (as percentage deviation from baseline).
Table 10.02
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Deriving the IS curve
Figure 10.05
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
De
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
DD i( )
DD
Y Y
Y=DD
i
A
Identifying an equilibrium combination of i and Y
Figure 10.05
A
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
De
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
DD i( )
DD i( )
DD
Y
DD
Y Y Y
Y=DD
i
iB
A
i i
Equilibrium output will change if the interest rate changes
A
Figure 10.05
B
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
iDe
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
DD i( )
DD i( )
DD
Y
DD
Y Y Y
A
ISY=DD
iB
A
i i
IS curve derived by finding Y’s for all i’s
Figure 10.05
B
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
De
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
DD i( )
DD i( )
DD
Y
DD
Y Y Y
A
ISY=DD
i
iB
A
i i
To the right of the IS curve supply of goods exceeds their demand
Excess supply of
goods
DD i( )
i
Figure 10.05
B
D
C
D
C
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Inte
rest
rat
e
Output
B
A
IS
Excess supply of
goods
Excess demand
for goods
To the left of the IS curve demand for goods exceeds their supply
Convince yourself
that this is true!
Hint: interest rates are lower than
along the IS curve where Y=DD(i)
Figure 10.05
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous increase in aggregate demand
Figure 10.06
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
De
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
( )DD G,i
ADD
Y
Y=DD
Start from equilibrium in the goods market...
IS
Y
iA
Figure 10.06
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
De
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
( )DD G ,iB
A
DD
Y Y Y
Y=DD
i
Exogenous increase in aggregate demand(e.g. G increases, but hold i constant at first)
A
IS
B( )DD G,i
DD
Y
Figure 10.06
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
De
sire
d d
em
an
d
Output
Inte
rest
rat
e
Output
( )DD G ,iB
A
DD
Y Y Y
IS´
Y=DD
i
Similar shift to that from A to B would occur for all other values of the interest rate
A
IS
B( )DD G,i
DD
Y
Figure 10.06
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Figure 10.07
GDP growth and Tobin’s q in the USA
30
40
50
60
70
80
90
100
110
Jan/95 Jan/96 Jan/97 Jan/98 Jan/99 Jan/00 Jan/01 Jan/02 Jan/03
-2
-1
0
1
2
3
4
5
6
Tobin's q (left scale: 2000=100) GDP growth (right scale)
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Deriving the LM curve
Figure 10.08
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
OutputY
i
Holding the real money supply constant, we determine i for some given level of output...
i
Y,i c( , )L
M P
Realmoneysupply
AA
Figure 10.08
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
OutputY Y
i
Same question for a higher level of output...
i
i
Y,i c( , )L
Y ,i c( , )L
i
M P
Realmoneysupply
A
B
A
Figure 10.08
B
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
OutputY Y
LM
i
LM curve derived by finding i’s for all Y’s
i
i
Y,i c( , )L
Y ,i c( , )L
i
M P
Realmoneysupply
A
BB
A
Figure 10.08
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
OutputY Y
LM
i
To the right of the LM curve demand for real balances exceeds their supply
i
i
Y,i c( , )L
Y ,i c( , )L
i
M P
Realmoneysupply
A
BExcess demand
for money
CC
Figure 10.08
B
A
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
OutputY Y
A
LM
i
To the left of the LM curve supply of real balances exceeds their demand
i
i
Y,i c( , )L
Y ,i c( , )L
i
M P
Realmoneysupply
A
B
Excess supply of money
CC
Figure 10.08
B
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Output
LM
Excess demand
for money
Excess supply of money
Money market equilibrium on the LM curve
Figure 10.08
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Increasing money supply shifts LM outward
Figure 10.09
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
Output
A
M P Y Y
BA
LM´
i
Increasing money supply shifts LM outward(at the same interest rate, we need Y to go up for greater D)
i
D= Y,i cL ( , )
Realmoneysupply LM
B
Figure 10.09
D= Y´,i cL ( , )
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Real money stock
Output
A
M P Y
A
LM´
i
Increasing money supply shifts LM outward(at the same Y, we need i to go down)
i
D= Y,i cL ( , )
Realmoneysupply LM
CC
Figure 10.09
No
min
al n
tere
st r
ate
No
min
al n
tere
st r
ate
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eThe balance of payments line
Figure 10.10
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
General equilibrium
Figure 10.11
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Inte
rest
rat
e
IS
Equilibrium in the goods market
Changes in output will occur when we are not on the IS curve (as response to shortage to the left of IS and surplus to the right).
Figure 10.11
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Inte
rest
rat
e
LM
Equilibrium in the money market
Changes in the interest rate will occur when we are not on the LM curve. Below LM there is an excess demand for money (bonds chase money). Above the LM there is an excess supply of money (money chases bonds).
Figure 10.11
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Output
Inte
rest
rat
eEquilibrium in international capital markets
When domestic and foreign rates of return are not the same, capital will flow towards the higher returns until returns are equalized.
Figure 10.11
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eGeneral equilibrium
LM
IS
A
Figure 10.11
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Money policy under fixed exchange rates
Figure 10.12
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
Starting from general equilibrium, there is an unanticipated increase in the supply of money
Figure 10.12
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
Starting from general equilibrium, there is an unanticipated increase in the supply of money
LM´
Figure 10.12
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
IS
A
Note: points A,B,C each satisfy only twoof three equilibrium conditions
LM´
C
BThis condition is not moving!
Figure 10.12
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
IS
A
Implication of fixed exchange rates in this case: No reason for the IS curve to move.
LM´
C
BThis condition is not moving either!
Figure 10.12
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
IS
A
The central bank has to bring LM back to the original position to keep the exchange rate fixed.
LM´
Figure 10.12
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
The central bank has to bring LM back to the original position to keep the exchange rate fixed.
LM´
Monetary policy is ineffective for changing output.
Figure 10.12
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous changeFixed exchange rates
Flexible exchange rates
Expansionary demand disturbance Increase No effect
Expansionary monetary disturbance No effect Increase
Increase in foreign interest rates Decrease Increase
Effect on real GDP
The Mundell-Fleming model: Summary
Table 10.04
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Table 10.3
Sterilized and unsterilizedforeign exchange market interventions
M0 F DC M0 F DC
Step 1 – – = – – =Step 2 + +Overall – – = = – +
Unsterilized interventions Sterilized interventions
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Demand disturbance, fixed exchange rates
Figure 10.13
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eStarting from general equilibrium, there is an
unanticipated increase in the demand for goods
LM
IS
A
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eStarting from general equilibrium, there is an
unanticipated increase in the demand for goods
LM
IS
A
IS´
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eNote: points A,B,C each satisfy only two
of three equilibrium conditions
This condition is not moving!
LM
AB
IS´
C
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eImplication of fixed exchange rates in this case:
No reason for the IS curve to move (further).
This condition is not moving either!
LM
AB
IS´
C
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eThe central bank has to move LM to the right to
maintain the fixed exchange rate.
LM
IS´
C
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
LM´
i*Financial integration line
Inte
rest
rat
eThe central bank has to move LM to the right to
maintain the fixed exchange rate.
Fiscal policy is effective for changing output.
LM
IS´
C
Note: M0 increased by forex purchases of the central bank.
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eReview: Demand disturbance, fixed exchange
rate, no capital controls
LM
IS
A
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eReview: Demand disturbance, fixed exchange
rate, no capital controls
LM
IS
A
IS´
Figure 10.13
Output
C
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
LM´
i*Financial integration line
Inte
rest
rat
eReview: Demand disturbance, fixed exchange
rate, no capital controls
LM
IS
A
IS´
Figure 10.13
Output
C
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous changeFixed exchange rates
Flexible exchange rates
Expansionary demand disturbance Increase No effect
Expansionary monetary disturbance No effect Increase
Increase in foreign interest rates Decrease Increase
Effect on real GDP
The Mundell-Fleming model: Summary
Table 10.04
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eCompare: Demand disturbance, fixed exchange
rate, with capital controls
LM
IS
A
Figure 10.13
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
eCompare: Demand disturbance, fixed exchange
rate, with capital controls
LM
IS
A
IS´
Figure 10.13
Output
B
Note: central bank independence is possible for a short-time now
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Figure 10.14
Argentina 1993-2003
-5
0
5
10
15
20
25
30
35
40
45
50
1992Q1 1994Q1 1996Q1 1998Q1 2000Q1 2002Q1
0.2
0.4
0.6
0.8
1
Inflation (left scale) Dollar per peso (right scale)
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Policy mix
Figure 10.15
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
Policy mix: monetary policy moves with fiscal policy deliberately to change output holding i=i*
Figure 10.15
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
Policy mix: monetary policy moves with fiscal policy deliberately to change output holding i=i*
B
IS´
LM´ M0 increased by securities purchases by central bank.
Figure 10.15
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Financial disturbance, fixed exchange rate
Figure 10.16
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*
Inte
rest
rat
e
IS
Increase in rate of return on foreign assets,fixed exchange rate
LM
A
Figure 10.16
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*
Inte
rest
rat
e
LM
IS
Increase in rate of return on foreign assets,fixed exchange rate
A
i*´
This condition is not moving!
Figure 10.16
Output
Note: M0 will fall due to forex sales by central bank.
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*
Inte
rest
rat
e
LM
IS
B
Increase in rate of return on foreign assets,fixed exchange rate
LM´
A
i*´
This condition is not moving!
Note: M0 will fall due to forex sales by central bank.
Figure 10.16
Output
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous changeFixed exchange rates
Flexible exchange rates
Expansionary demand disturbance Increase No effect
Expansionary monetary disturbance No effect Increase
Increase in foreign interest rates Decrease Increase
Effect on real GDP
The Mundell-Fleming model: Summary
Table 10.04
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
A devaluation
Figure 10.17
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
To devalue the currency the central bank will bid up the price of foreign money, creating more M0
Output
Figure 10.17
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
To devalue the currency the central bank will bid up the price of foreign money, creating more M0
LM´
Output
Figure 10.17
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
To devalue the currency the central bank will bid up the price of foreign money, creating more M0
IS´
LM´
Lower S increases demand for goods.
Output
Figure 10.17
C
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Demand disturbance, flexible exchange rates
Figure 10.18
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
A
Real demand increases…
IS
Output
Figure 10.18
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
A
Real demand increases…
IS´IS
B
Output
Figure 10.18
However, the resulting increase in S will reduce the demand for goods.
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
…i>i* will attract capital inflows, so S appreciates
B
IS´
However, the resulting increase in S will reduce the demand for goods.
Output
Figure 10.18
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous changeFixed exchange rates
Flexible exchange rates
Expansionary demand disturbance Increase No effect
Expansionary monetary disturbance No effect Increase
Increase in foreign interest rates Decrease Increase
Effect on real GDP
The Mundell-Fleming model: Summary
Table 10.04
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Monetary policy under flexible exchange rates
Figure 10.19
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
i*Financial integration line
Inte
rest
rat
e
LM
IS
A
Increase in money supply lowers the interest rate
IS´
C
LM´
B
Exchange rate depreciates increasing the demand for goods.
Output
Figure 10.19
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous changeFixed exchange rates
Flexible exchange rates
Expansionary demand disturbance Increase No effect
Expansionary monetary disturbance No effect Increase
Increase in foreign interest rates Decrease Increase
Effect on real GDP
The Mundell-Fleming model: Summary
Table 10.04
Burda, Wyplosz MACROECONOMIA: UNA PROSPETTIVA EUROPEA
©EGEA 2006
Exogenous changeFixed exchange rates
Flexible exchange rates
Expansionary demand disturbance Increase No effect
Expansionary monetary disturbance No effect Increase
Increase in foreign interest rates Decrease Increase
Effect on real GDP
The Mundell-Fleming model: Summary
Table 10.04
Fixed exchange rates
Flexible exchange rates
Exogenous monetary instrument Exchange rate Money supply
Endogenous monetary instrument Money supply Exchange rate