1 Autonomous Planned Aggregate Expenditure rises at any level of the interest rate. The level of output that satisfies goods‐market equilibrium rises, raising money demand. This raises domestic interest rates in the combined equilibrium. Higher domestic interest rates attract foreign capital. By the Interest Parity condition, $£󰇡󰇢, if the foreign interest rate (£) and the expected exchange rate () are unchanged, the currency appreciates. Net exports fall for two reasons: higher output raises imports; the currency appreciation makes exports more expensive and imports cheaper – by the Marshall‐Lerner condition, net exports fall. Expansionary Monetary Policy increases the money su pply at any level of output. The level of interest rates that satisfies money‐market equilibrium falls, which raises investment and (by the multiplier process), expenditure and output. Lower domestic interest rates repel foreign capital. By the Interest Parity condition, if £ and  are unchanged, the currency depreciates. The effect on net exports is ambiguous: higher output raises imports (which pressures net exports down); but the currency depreciation makes exports cheaper and imports more expensive (which pressures net exports up). i YLMISiEIP i ForeignEeE>Ee i>i ForeignLMISi YIP iEEei foreign2 Foreign Monetary Policy turns expansionary, but the exchange rate is fixed. Foreign interest rates fall. The Interest Parity condition line shifts down. If  is unchanged, the domestic interest rate must fall by exactly the same amount to prevent the currency from appreciating (moving from point 1 to point 2). The Central Bank, which is in charge of keeping the exchange rate constant, must engineer a monetary expansion to bring interest rates down, following the lead of the foreign Central Bank. LM shifts right, increasing output (moving from point 1 to point 2). Since the exchange rate does not change and output increases, net exports fall. Foreign Monetary Policy turns expansionary. The exchange rate is flexible. Foreign interest rates fall. The Interest Parity condition line shifts down. If  is unchanged and domestic interest rates stay constant, the currency appreciates (from point 1 to point 2). However, the appreciation of the currency pushes net exports down, so the IS curve shifts to the left (from point 1 to point 2). This lowers domestic interest rates somewhat and, by pushing the exchange rate up, moderates the appreciation of the currency (moving to point 3). We know domestic interest rates don’t fall as much as the foreign interest rate, because the reason for the decline in interest rates is precisely that $£ (which caused the currency appreciation, the decline in NX, and the leftward shift of IS). i YLMISiEIP i ForeignE=Ee i Foreign (new)(2)(1)i=i Foreign (1) (2) LM’i YLMISiEIP i ForeignEeE<Eei<i ForeignLM’3 The exchange rate is flexible. The Expected Exchange Rate rises (for a constant i Foreign). The IP line shifts right. If neither domestic nor foreign interest rates change, E appreciates. This depresses net exports, so the IS curve shifts left, lowering interest rates and making the currency appreciate by less. Taxes rise Is this a goods‐market, a money‐market, or a foreign‐exchange market event? If it’s a goods‐ or money‐market event, what happens to output and interest rates? what happens to the exchange rate? what is the combined effect on net exports of the change in Y and the change in E? If it’s a foreign‐exchange‐market event, if the exchange rate is flexible, what happens to the exchange rate (at any level of the interest rate)? what is the effect of this change in E on net exports? if the exchange rate is fixed, what happens to the interest rate? what is the effect of this change in interest rates on output and on net exports? i YLMISiEIP i ForeignEeEe (new) (2) (1)(3) I<i Foreign (1) (3) (2) E<Ee (new) i YLMISiEIP i ForeignEeE>Ee i Foreign (new) ‐‐‐(2) (1)(3) i>i Foreign (1) (3) (2) 4 In a preemptive strike against inflation, the Central Bank tightens monetary policy. (answer the questions from the previous exercise) The exchange rate is fixed. Interest rates rise in the foreign country. (answer the questions from the previous exercise) i YLMISiEIP i ForeignEei YLMISiEIP i ForeignEei YLMISiEIP i ForeignEe5 The exchange rate is flexible (that is, the Central Bank is not committed to any particular level of the exchange rate, and will let it float). Interest rates rise in the foreign country. (answer the questions from the previous exercise) The exchange rate is flexible. Events convince the market that the exchange rate will be lower in the future than it is today (for a constant i Foreign). (answer the questions from the previous exercise) (Optional: these are harder, but very interesting and realistic topics in International Macro:) The exchange rate is fixed, but the market does not believe that the central bank can keep it fixed. The Expected Exchange Rate rises (for a constant i Foreign). (answer the questions from the previous exercise) i YLMISiEIP i ForeignEei YLMISiEIP i ForeignEe6 (Optional: these are harder, but very interesting and realistic topics in International Macro:) The exchange rate is fixed, but the Expected Exchange Rate rises. However, the Foreign Central Bank wants to help out, and keep E fixed. Should it raise or lower i Foreign? (answer the questions from the previous exercise) i YLMISiEIP i ForeignEei YLMISiEIP i ForeignEe7 Autonomous Planned Aggregate Expenditure () rises, so equilibrium output rises. Imports rise and exports stay constant. Net exports fall due to the rise in output, so the country moves along its NX curve. Y=PAEPAE1 mpc–(im2)/εPAEYPAE'PAEYNX0NXY=PAEPAE=C+I+G+NX C–mpcT+IP+G+NX1mpc–(im2)/εPAE YNXY0NX8 The currency depreciates. By the Marshall‐Lerner condition, imports fall and exports rise. Net exports rise at any level of output, so the NX curve shifts up. The increase in net exports pushes up expenditure and raises the equilibrium level of output. Higher output raises imports (but doesn’t affect exports), so that net exports rise by less than the original increase. But net exports must increase in the end: the only reason that NX are being “pushed down” by higher output is higher NX. The output of the