1 Lecture 15 International Macroeconomics Econ 340 Outline: International Macroeconomics • Recall Macro from Econ 102 – Aggregate Supply and Demand – Policies • Effects ON the Exchange Market – Expansion – Interest Rate • Effects OF the Exchange Market – Depreciation via Trade – Depreciation via Net Wealth • Effects THOUGH the Exchange Market 2 Econ 340, Deardorff, Lecture 15: Int Macro Recall Macro from Econ 102 • Aggregate Supply and Demand Determine Y = GDP = Output = Income • This in turn implies level of Employment P = Price level 3 Econ 340, Deardorff, Lecture 15: Int Macro Recall Macro from Econ 102 Y Y YN P LRAS SRAS AD Short-run Aggregate Supply Long-run Aggregate Supply Aggregate Demand Natural Rate of Output ( = Output at Natural Rate of Unemployment) 4 Econ 340, Deardorff, Lecture 15: Int Macro Recall Macro from Econ 102 • Macroeconomic Policies – Monetary Expansion = Increase in Money Supply (M) • Open market operations: purchase bonds • Reserve requirement: reduce it • Discount rate: reduce it • Usually indicated by Fed target for Federal Funds Rate – Fiscal Expansion • Increase government purchases (G) • Reduce taxes (T) – All of these have the effect of • Increasing aggregate demand • Shifting AD curve to the right They differ in effects on interest rate (i): • ΔM>0 lowers i • ΔG>0, ΔT<0 raise i 5 Econ 340, Deardorff, Lecture 15: Int Macro Recall Macro from Econ 102 YN P LRAS SRAS AD AD′ Short-run change Long-run change ΔM>0, ΔG>0, or ΔT<0, 6 Econ 340, Deardorff, Lecture 15: Int Macro2 Recall Macro from Econ 102 • Macroeconomic Policies – Contractionary policies (ΔM<0, ΔG<0, or ΔT>0) are just the opposite – All have only temporary effects on output and employment, but lasting effects on price level – Policies can be useful (if done right) for dealing with temporary problems such as a recession 7 Econ 340, Deardorff, Lecture 15: Int Macro Outline: International Macroeconomics • Recall Macro from Econ 102 – Aggregate Supply and Demand – Policies • Effects ON the Exchange Market – Expansion – Interest Rate • Effects OF the Exchange Market – Depreciation via Trade – Depreciation via Net Wealth • Effects THOUGH the Exchange Market 8 Econ 340, Deardorff, Lecture 15: Int Macro Effects ON the Exchange Market • Non-Monetary Expansion Y rises P rises i rises – We’ll always assume that the interest rate effect is larger, because capital today is very mobile – Three cases to consider: • Floating exchange rate • Pegged exchange rate at overvalued rate • Pegged exchange rate at undervalued rate ⇒ imports rise ⇒ D€ shifts right ⇒ capital inflow ⇒ S€ shifts right 9 Econ 340, Deardorff, Lecture 15: Int Macro • US Non-Monetary Expansion: Floating Exchange Rate S€0 D€0 Q€ E = $/€ E0 D€1 E1 ΔG>0, ΔT<0 S€1 ⇒Causes dollar to appreciate (Due to ΔY>0, ΔP>0) (Due to Δi>0) 10 Econ 340, Deardorff, Lecture 15: Int Macro • US Non-Monetary Expansion: Pegged Exchange Rate - Overvalued S€0 I1 Q€ E = $/€ D€1 ΔG>0, ΔT<0 S€1 ⇒Less intervention (sells) E* I0 D€0 (I1 < I0) 11 Econ 340, Deardorff, Lecture 15: Int Macro • US Non-Monetary Expansion: Pegged Exchange Rate - Undervalued S€0 I1 Q€ E = $/€ D€1 ΔG>0, ΔT<0 S€1 ⇒More intervention (buys) E* I0 D€0 12 Econ 340, Deardorff, Lecture 15: Int Macro3 Effects ON the Exchange Market • Summary: Non-Monetary Expansion – Results: Effects of non-monetary expansion • Floating exchange rate appreciates • Pegging the exchange rate becomes easier – If reserves were falling (overvalued case) they now fall less rapidly – If reserves were rising (undervalued case) they now rise more rapidly 13 Econ 340, Deardorff, Lecture 15: Int Macro Effects ON the Exchange Market • Monetary Contraction (i.e., rise in interest rate) Y falls P falls i rises – Assume again that the interest rate effect is larger – Same three cases • Will only show floating case; others are similar ⇒ imports fall ⇒ D€ shifts left ⇒ capital inflow ⇒ S€ shifts right 14 Econ 340, Deardorff, Lecture 15: Int Macro • US Monetary Contraction: Floating Exchange Rate S€0 D€0 Q€ E = $/€ E0 D€1 E1 ΔM<0 S€1 ⇒Causes dollar to appreciate (Due to ΔY<0, ΔP<0) (Due to Δi>0) 15 Econ 340, Deardorff, Lecture 15: Int Macro Effects ON the Exchange Market • Summary: Monetary Contraction – Assuming (always) that the interest-rate effect on capital flows is larger than the income and price effects on trade – Monetary contraction has essentially the same effects as a non-monetary (e.g., fiscal) expansion – Reason: • Only the interest rate really matters, due to assumption that capital flows dominate • And both fiscal expansion and monetary contraction raise the interest rate 16 Econ 340, Deardorff, Lecture 15: Int Macro Outline: International Macroeconomics • Recall Macro from Econ 102 – Aggregate Supply and Demand – Policies • Effects ON the Exchange Market – Expansion – Interest Rate • Effects OF the Exchange Market – Depreciation via Trade – Depreciation via Net Wealth • Effects THOUGH the Exchange Market 17 Econ 340, Deardorff, Lecture 15: Int Macro Effects OF the Exchange Market • Under a pegged exchange rate, the exchange market has little effect on the economy unless the pegged rate itself is changed – Exception: without sterilization, domestic money supply is sensitive to trade and capital flows • Under a floating exchange rate, movement of the exchange rate can matter a lot 18 Econ 340, Deardorff, Lecture 15: Int Macro4 Effects OF the Exchange Market • Thus, in both cases, we want to know effects of changing the exchange rate • We’ll look only at an exchange depreciation – (Usually called a “devaluation” when a pegged exchange rate is depreciated) 19 Econ 340, Deardorff, Lecture 15: Int Macro Effects OF the Exchange Market • Two Major Effects of Exchange-Rate Depreciation – Trade Effect • Depreciation makes country’s goods cheaper – Wealth Effect • Depreciation makes
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