40
Open Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short Run

Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

  • Upload
    others

  • View
    15

  • Download
    0

Embed Size (px)

Citation preview

Page 1: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Open Economy in the Short Run

Intermediate Macroeconomic TheoryMacroeconomic Analysis

University of North Texas

ECON 3560 / 5040 Open Economy in the Short Run

Page 2: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Outline

1 Aggregate Demand in the Open Economy

2 The Small Open Economy under Floating Exchange Rates

3 The Small Open Economy under Fixed Exchange Rates

4 Should Exchange Rates Be Floating or Fixed?

5 The Mundell-Fleming Model with a Changing Price

ECON 3560 / 5040 Open Economy in the Short Run

Page 3: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Outline

1 Aggregate Demand in the Open Economy

2 The Small Open Economy under Floating Exchange Rates

3 The Small Open Economy under Fixed Exchange Rates

4 Should Exchange Rates Be Floating or Fixed?

5 The Mundell-Fleming Model with a Changing Price

ECON 3560 / 5040 Open Economy in the Short Run

Page 4: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 5: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The SR model of national income including the effects ofinternational trade and finance

The behavior of an economy depends on the exchange-ratesystem it has adopted

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 6: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 7: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 8: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 9: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 10: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 11: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Aggregate Demand in the Open EconomyMondell-Fleming Model

The Mondell-Fleming Model: an international version of theIS− LM model (IS∗ − LM∗ model)

The key assumption: small open economy with perfect capitalmobility (r = r∗)

The goods market and the IS∗ curve

⇒ Y = C(Y − T) + I(r∗) + G + NX(e)

The money market and the LM∗ curve

⇒ M/P = L(r∗, Y)

Equilibrium exchange rate and income

ECON 3560 / 5040 Open Economy in the Short Run

Page 12: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Outline

1 Aggregate Demand in the Open Economy

2 The Small Open Economy under Floating Exchange Rates

3 The Small Open Economy under Fixed Exchange Rates

4 Should Exchange Rates Be Floating or Fixed?

5 The Mundell-Fleming Model with a Changing Price

ECON 3560 / 5040 Open Economy in the Short Run

Page 13: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Floating ExchangeRates

Floating exchange rates: the exchange rate is allowed tofluctuate freely in response to changing economic conditions

1 Fiscal Policy

↑ G(↓ T) ⇒ ↑ e and Y

2 Monetary Policy

↑ M ⇒ ↓ e and ↑ Y

3 Trade Policy

Trade restrictions ⇒ ↑ e and Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 14: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Floating ExchangeRates

Floating exchange rates: the exchange rate is allowed tofluctuate freely in response to changing economic conditions

1 Fiscal Policy

↑ G(↓ T) ⇒ ↑ e and Y

2 Monetary Policy

↑ M ⇒ ↓ e and ↑ Y

3 Trade Policy

Trade restrictions ⇒ ↑ e and Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 15: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Floating ExchangeRates

Floating exchange rates: the exchange rate is allowed tofluctuate freely in response to changing economic conditions

1 Fiscal Policy

↑ G(↓ T) ⇒ ↑ e and Y

2 Monetary Policy

↑ M ⇒ ↓ e and ↑ Y

3 Trade Policy

Trade restrictions ⇒ ↑ e and Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 16: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Floating ExchangeRates

Floating exchange rates: the exchange rate is allowed tofluctuate freely in response to changing economic conditions

1 Fiscal Policy

↑ G(↓ T) ⇒ ↑ e and Y

2 Monetary Policy

↑ M ⇒ ↓ e and ↑ Y

3 Trade Policy

Trade restrictions ⇒ ↑ e and Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 17: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Floating ExchangeRates

Floating exchange rates: the exchange rate is allowed tofluctuate freely in response to changing economic conditions

1 Fiscal Policy

↑ G(↓ T) ⇒ ↑ e and Y

2 Monetary Policy

↑ M ⇒ ↓ e and ↑ Y

3 Trade Policy

Trade restrictions ⇒ ↑ e and Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 18: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Floating ExchangeRates

Floating exchange rates: the exchange rate is allowed tofluctuate freely in response to changing economic conditions

1 Fiscal Policy

↑ G(↓ T) ⇒ ↑ e and Y

2 Monetary Policy

↑ M ⇒ ↓ e and ↑ Y

3 Trade Policy

Trade restrictions ⇒ ↑ e and Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 19: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Outline

1 Aggregate Demand in the Open Economy

2 The Small Open Economy under Floating Exchange Rates

3 The Small Open Economy under Fixed Exchange Rates

4 Should Exchange Rates Be Floating or Fixed?

5 The Mundell-Fleming Model with a Changing Price

ECON 3560 / 5040 Open Economy in the Short Run

Page 20: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 21: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

The commitment of the central bank to allow the money supplyto adjust to whatever level will ensure that the equilibriumexchange rate equals the announced exchange rate

Bretton Woods system: an international monetary system underwhich most governments agree to fix exchange rates in the1950s and 1960s

The fixed exchange rate governs the money supply1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y2 Monetary Policy

↑ M ⇒ e and Y3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 22: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 23: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 24: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 25: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 26: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 27: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Small Open Economy under Fixed ExchangeRates

How a fixed-exchange-rate system works

1 Fiscal Policy

↑ G(↓ T) ⇒ e and ↑ Y

2 Monetary Policy

↑ M ⇒ e and Y

3 Trade Policy

Trade restrictions ⇒ e and ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 28: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Outline

1 Aggregate Demand in the Open Economy

2 The Small Open Economy under Floating Exchange Rates

3 The Small Open Economy under Fixed Exchange Rates

4 Should Exchange Rates Be Floating or Fixed?

5 The Mundell-Fleming Model with a Changing Price

ECON 3560 / 5040 Open Economy in the Short Run

Page 29: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Should Exchange Rates Be Floating or Fixed?

Most economists have favored a system of floating exchangerates

In recent years, some have advocated a return to a fixedexchange rate

The role of monetary policy

Advocates of fixed exchange rates

ECON 3560 / 5040 Open Economy in the Short Run

Page 30: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Should Exchange Rates Be Floating or Fixed?

Most economists have favored a system of floating exchangerates

In recent years, some have advocated a return to a fixedexchange rate

The role of monetary policy

Advocates of fixed exchange rates

ECON 3560 / 5040 Open Economy in the Short Run

Page 31: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Should Exchange Rates Be Floating or Fixed?

Most economists have favored a system of floating exchangerates

In recent years, some have advocated a return to a fixedexchange rate

The role of monetary policy

Advocates of fixed exchange rates

ECON 3560 / 5040 Open Economy in the Short Run

Page 32: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Should Exchange Rates Be Floating or Fixed?

Most economists have favored a system of floating exchangerates

In recent years, some have advocated a return to a fixedexchange rate

The role of monetary policy

1 Fixed rates: the single goal of maintaining the exchange rate atits announced level

2 Floating rates: monetary policymakers free to pursue othergoals; stabilizing employment (output) or price

Advocates of fixed exchange rates

ECON 3560 / 5040 Open Economy in the Short Run

Page 33: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Should Exchange Rates Be Floating or Fixed?

Most economists have favored a system of floating exchangerates

In recent years, some have advocated a return to a fixedexchange rate

The role of monetary policy

Advocates of fixed exchange rates

ECON 3560 / 5040 Open Economy in the Short Run

Page 34: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Should Exchange Rates Be Floating or Fixed?

Most economists have favored a system of floating exchangerates

In recent years, some have advocated a return to a fixedexchange rate

The role of monetary policy

Advocates of fixed exchange rates

1 Exchange rate uncertainty makes international trade moredifficult

2 Irrational and destabilizing speculation by international investors

ECON 3560 / 5040 Open Economy in the Short Run

Page 35: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

Outline

1 Aggregate Demand in the Open Economy

2 The Small Open Economy under Floating Exchange Rates

3 The Small Open Economy under Fixed Exchange Rates

4 Should Exchange Rates Be Floating or Fixed?

5 The Mundell-Fleming Model with a Changing Price

ECON 3560 / 5040 Open Economy in the Short Run

Page 36: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Mundell-Fleming Model with a Changing Price

The Mundell-Fleming Model:

1 IS∗: Y = C(Y − T) + I(r∗) + G + NX(e)

2 LM∗: M/P = L(r∗, Y)

Aggregate Demand: negative relationship between P and Y

↓ P ⇒ ↑ (M/P) ⇒ ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 37: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Mundell-Fleming Model with a Changing Price

The Mundell-Fleming Model:

1 IS∗: Y = C(Y − T) + I(r∗) + G + NX(e)

2 LM∗: M/P = L(r∗, Y)

Aggregate Demand: negative relationship between P and Y

↓ P ⇒ ↑ (M/P) ⇒ ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 38: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Mundell-Fleming Model with a Changing Price

The Mundell-Fleming Model:

1 IS∗: Y = C(Y − T) + I(r∗) + G + NX(e)

2 LM∗: M/P = L(r∗, Y)

Aggregate Demand: negative relationship between P and Y

↓ P ⇒ ↑ (M/P) ⇒ ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 39: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Mundell-Fleming Model with a Changing Price

The Mundell-Fleming Model:

1 IS∗: Y = C(Y − T) + I(r∗) + G + NX(e)

2 LM∗: M/P = L(r∗, Y)

Aggregate Demand: negative relationship between P and Y

↓ P ⇒ ↑ (M/P) ⇒ ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run

Page 40: Open Economy in the Short RunOpen Economy in the Short Run Intermediate Macroeconomic Theory Macroeconomic Analysis University of North Texas ECON 3560 / 5040 Open Economy in the Short

The Mundell-Fleming Model with a Changing Price

The Mundell-Fleming Model:

1 IS∗: Y = C(Y − T) + I(r∗) + G + NX(e)

2 LM∗: M/P = L(r∗, Y)

Aggregate Demand: negative relationship between P and Y

↓ P ⇒ ↑ (M/P) ⇒ ↑ Y

ECON 3560 / 5040 Open Economy in the Short Run