19 Exchange Exchange Rates Rates and and the the Macroeconomy Macroeconomy No Noman manisisan anisland island entire entire of of itself itself JOHN JOHNDONNE DONNE Contents Contents International International Trade Trade Exchange Exchange Rates Rates and and Aggregate Aggregate Demand Demand Aggregate Aggregate Supply Supply in in an an Open Open Economy Economy The The Macroeconomic Macroeconomic Effects Effects of of Exchange Exchange Rates Rates Fiscal Fiscal and and Monetary Monetary Policies Policies in in an an Open Open Economy Economy Copyright 2006 South Western Thomson Learning All rights reserved Contents Contents continued continued International InternationalAspects Aspects of of Deficit Deficit Reduction Reduction Is Is the the Trade Trade Deficit Deficit aa Problem Problem On On Curing Curing the the Trade Trade Deficit Deficit Conclusion Conclusion No No Nation Nation isis an an Island Island Copyright 2006 South Western Thomson Learning All rights reserved International International Trade Trade Exchange Exchange Rates Rates and and AD AD exports exports and and imports imports multiplier multiplier effects effects on on GDP GDP Booms Booms or or recessions recessions in in one one country country affect affect other other countries countries through through international international trade trade Copyright 2006 Southwestern Thomson Learning All rights reserved International International Trade Trade Exchange Exchange Rates Rates and and AD AD Relative Relative Prices Prices Exports Exports and and Imports Imports relative relative prices prices of of aa country s country s exports exports that that country s country s net net exports exports its its real real GDP GDP Copyright 2006 Southwestern Thomson Learning All rights reserved International International Trade Trade Exchange Exchange Rates Rates and and AD AD Relative Relative Prices Prices Exports Exports and and Imports Imports relative relative prices prices of of aa country s country s exports exports that that country s country s net net exports exports its its real real GDP GDP Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 1 1 The The Effects Effects of of Higher Higher Net Net Exports Exports S D1 D0 Price Level B D1 A D0 S Real GDP Copyright 2006 South Western Thomson Learning All rights reserved International International Trade Trade Exchange Exchange Rates Rates and and AD AD The The Effects Effects of of Changes Changes in in Exchange Exchange Rates Rates A Acurrency currency depreciation depreciation relative relative prices prices of of the the country s country s goods goods in in international international trade trade its its net net exports exports and andAD AD A Acurrency currency appreciation appreciation has has the the opposite opposite effects effects Copyright 2006 Southwestern Thomson Learning All rights reserved TABLE TABLE 1 1 Exchange Exchange Rates Rates and and Home Home Currency Currency Prices Prices Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 2 2 The The Effects Effects of of Exchange Exchange Rate Rate Changes Changes on on AD AD D1 S D0 E1 Price Level D2 E0 D1 depreciation E2 D0 D2 appreciation S Real GDP Copyright 2006 South Western Thomson Learning All rights reserved Aggregate Aggregate Supply Supply in in an an Open Open Economy Economy Open Open Economy Economy one one that that trades trades with with other other nations nations in in goods goods and and services services and and perhaps perhaps also also in in financial financial assets assets Closed Closed Economy Economy one one that that does does not not trade trade with with other other nations nations in in either either goods goods or or assets assets Copyright 2006 Southwestern Thomson Learning All rights reserved Aggregate Aggregate Supply Supply in in an an Open Open Economy Economy A Acurrency currency depreciation depreciation price price of of foreign foreign goods goods AS AS shifts shifts inward inward A Acurrency currency appreciation appreciation has has the the opposite opposite effects effects Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 3 3 The The Effects Effects of of Exchange Exchange Rate Rate Changes Changes on on AS AS S1 depreciation S0 D Price Level S2 appreciation E1 E0 E2 S1 S0 S2 D Real GDP Copyright 2006 South Western Thomson Learning All rights reserved The The Macroeconomic Macroeconomic Effects Effects of of Exchange Exchange Rates Rates Currency Currency depreciation depreciation AD AD and and AS AS Net Net result result isis inflation inflation Probably Probably also also expansionary expansionary Impact Impact on onAD AD dominates dominates impact impact on onAS AS A Acurrency currency appreciation appreciation has has the the opposite opposite effects effects Copyright 2006 Southwestern Thomson Learning All rights reserved FIGURE FIGURE 4 4 The The Effects Effects of of aa Currency Currency Depreciation Depreciation S1 D1 S0 Price Level D0 A E D1 S1 S0 D0 Real GDP Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 5 5 The The Effects Effects of of aa Currency Currency Appreciation Appreciation S0 D0 S2 Price Level D2 E S0 B D0 S2 D2 Real GDP Copyright 2006 South Western Thomson Learning All rights reserved The The Macroeconomic Macroeconomic Effects Effects of of Exchange Exchange Rates Rates Interest Interest Rates Rates and and International International Capital Capital Flows Flows interest interest rates rates Attracts Attracts foreign foreign capital capital flows flows Appreciates Appreciates the the currency currency net net exports exports GDP GDP interest interest rates rates has has the the opposite opposite effects effects Copyright 2006 Southwestern Thomson Learning All rights reserved Fiscal Fiscal and and Monetary Monetary Policies Policies in in an an Open Open Economy Economy Fiscal Fiscal Policy Policy Revisited Revisited Expansionary Expansionary fiscal fiscal policy policy interest interest rates rates Attracts Attracts foreign foreign capital capital Appreciates Appreciates the the currency currency net net exports exports Copyright 2006 Southwestern Thomson Learning All rights reserved Fiscal Fiscal and and Monetary Monetary Policies Policies in in an an Open Open Economy Economy Fiscal Fiscal Policy Policy Revisited Revisited Part Part of of the the expansionary expansionary effect effect of of fiscal fiscal policy policy