Jim Whitney | Economics 311 |
Open-economy macroeconomics: short-run policy effects with fixed exchange rates
Example 1: Expansionary monetary policy: | |
(1) +M/P => LM shifts right => +Y, -r (2) -r => K-outflows => NFI shifts right => pressure for currency depreciation (3) -M/P to prevent depreciation => LM shifts back (4) +r back to initial equilibrium => NFI shifts back as well. |
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Overall results: monetary policy does not work |
Example 2: Expansionary fiscal policy: | |
(1) +G => IS shifts right => +Y,+r (2) +r => incentive for K-inflows => NFI shifts left (3) LM shifts right as Fed supplies domestic currency prevent appreciation. (until r returns to initial level.) (5) NFI shifts right due to expansionary monetary policy. (R returns to initial fixed level.) |
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Overall results: +Y, no SR change in r, -NX, no SR change in
R. But note: Yb>Yf => pressure for self-correction via inflation in the long run. As long as the expansionary fiscal policy persists, the short-run process keeps repeating itself, and the nation's money supply keeps growing until inflation pushes R up until it passes through point * in the foreign-sector diagram. At that point, the economy will have its excess spending financed by capital inflows, just as it would have via nominal currency appreciation with floating exchange rates. |