Lecture 11: Mundell-Fleming and Exchange Rate Systems • Mundell-Fleming • Fixed exchange rates – Policy –Crises • Expectations------Mundell-Fleming IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*)) i IS LM Interest parity YE eE = E 1+i-i* * Fiscal and Monetary policyFixed Exchange Rates (Credible) - A little bit of it even in “flexible” exchange rates systems; “commitment” to E rather than M => i = i* => M = YL(i*) P - Central Bank gives up monetary policyi Interest parity i* IS LM YE - Fiscal and Monetary policy - Capital controls; imperfect capital flowsCrises in Fixed Exchange Rate Systems i = i* + (E(t+1) - E) / Ee * ERM crisis: Sweden (500%) 0% 5% 10% 15% 20% 25% 30% 35% 45% 50% 40% Jan-97Feb-97Mar-97Apr-97 May-97Jun-97Jul-97Aug-97Sep-97Oct-97 Nov-97 Dec-97Jan-98Feb-98Mar-98Apr-98 May-98Jun-98Jul-98Aug-98Sep-98Oct-98 Nov-98 Dec-98Jan-99Feb-99Mar-99Apr-99 May-99 Interbank Interest Rates BrazilMexicoMexicoArgentinaArgentinaFigure by MIT OCW.i i* IS LM YE Note: There is a shift in the IS as well… but this is small, especially in the short runExpected Events - Back to flexible exchange rates; expected M expansion i -5% E-E(-) 10% 5% 0 12
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