Lecture 10: The Goods Market and the Exchange Rate• Devaluations (static and dynamic responses) • Exchange rate determination (capital markets)• The open economy IS-LMThe Goods Market Z = C + I + G + X - e QC(Y-T) + I(Y,I) + GQ = Q(Y,e)+ -X = X(Y*,e)+ +Figures•Figs 19-4, 19-5• Increase in foreign demand• games countries play• depreciationThe J-Curve• eQ(Y,e) : increase or decrease with e?• In the very short run: it may increase!• And if strong enough: X(Y*,e) - eQ(Y,e) may do the same.• Dynamics of NX in response to a depreciation; fig 19-6The Exchange Rate Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E P*/P)constantThe Goods MarketFinancial MarketsM/P = YL(i)i(t) = i*(t) + E(t+1) - E(t)E(t)eCont. The Exchange RateEii*Eei = i* + E - EEgiven E and i*eeThe Open Economy IS-LMY = C(Y-T) + I(Y,i) + G + NX(Y,Y*,E)M = Y L(i)PE = E 1+i-i*eIS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*)) eiYEISLMInterest parityTwo IS caveats: a) Multiplier is smallerb) Interest rate affects aggregate demand through the E as well.* Fiscal and Monetary
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