Chapter 16 Output And The Exchange Rate In The Short Run

Determinants Of Aggregate Demand In An Open Economy Y d = Y –T C = C(Y d ) CA = EX – IM = CA ( EP ＊ /P, Y d )

where Y d is disposable income, E is the price of income, E is the price of foreign currency in terms of foreign currency in terms of domestic. P ＊ is the foreign domestic. P ＊ is the foreign price level, and P is the price level, and P is the home price level. home price level.

Change Change Effect on current Effect on current account, CA account, CA EP ＊ /p ↑ EP ＊ /p ↑ CA ↑ CA ↑ EP ＊ /p ↓ EP ＊ /p ↓ CA ↓ CA ↓ Y d ↑ Y d ↑ CA ↓ CA ↓ Y d ↓ Y d ↓ CA ↑ CA ↑

The Equation Of Aggregate Demand D = C( Y – T)+ I + G + CA( EP ＊ /P, Y – T) D = D(EP ＊ /P, Y –T, I, G)

A real depreciation of the home currency raises aggregate demand for home output, other things equal; a real appreciation lowers aggregate demand for home output. A real depreciation of the home currency raises aggregate demand for home output, other things equal; a real appreciation lowers aggregate demand for home output. A rise in domestic real income raises aggregate demand for home output, other things equal, and a fall in domestic real income lowers aggregate demand for home output. A rise in domestic real income raises aggregate demand for home output, other things equal, and a fall in domestic real income lowers aggregate demand for home output.

Output Market Equilibrium In The Short Run Aggregate demand,D D1D1D1D1 Y1Y1Y1Y1 Output, Y 1 D=Y D 45°

Output ， the Exchange Rate ， and Output Market Equilibrium Output Effect of a Currency Depreciation with Fixed Prices

Deriving the DD Schedule

Factors that shift the DD schedule 1. A change in G ( Figure16-5)Figure16-5 G↑→ D↑→ DD rightward 2. A change in T T↑→ Y d ↓→ D ↓ → DD leftward 3. A change in I I↑→ D↑→ DD rightward

Figure 16-5

4. A change in P P↑→ EX↓→ D ↓→ DD leftward P↑→ EX↓→ D ↓→ DD leftward 5. A change in P ＊ P ＊ ↑→IM↓→D↑→DD rightward P ＊ ↑→IM↓→D↑→DD rightward

6. A change in consumption function C = C(Y d ) = C[(1- )Y d ] C ↑ → D↑→ DD rightward 7. A demand shift between foreign and domestic goods EX↑, IM↓→D↑→DD rightward

Any disturbance that raises aggregate demand for domestic output shifts the DD schedule to the right.. Any disturbance that lowers aggregate demand for domestic output shifts the DD schedule to the left. Conclusion:

Asset Market Equilibrium In The Short Run: The AA Schedule Asset Market Equilibrium In The Short Run: The AA Schedule R = R ＊ + (E e – E)/E,where R is the interest rate on domestic currency deposits, R ＊ is the interest rate on foreign currency deposits, E e is a given expected future exchange rate.

Figure 16-6 Output and the Exchange Rate in Asset Market Equilibrium

For asset markets to remain in equilibrium, a rise in domestic output must be accompanied by an appreciation of the domestic currency, all else equal, and a fall in domestic output must be accompanied by a depreciation. Conclusion:

Exchange rate, E Output, Y Y1Y1Y1Y1 E1E1E1E1 Y2Y2Y2Y2 E2E2E2E2 1 2 The AA Schedule Deriving the AA Schedule

Factors that shift the AA schedule A change in M s M s ↑→ E ↑ → AA upward 2. A change in P P ↑ → M s /P → R ↑ → E↓ →AA downward

3. A change in E e E e ↑→ E ↑ → AA upward 4. A change in R ＊ R ＊ ↑ → E ↑ → AA upward 5. A change in real money demand L(R,Y) ↓ →R ↓→ E ↑ → AA upward

Short-Run Equilibrium For An Open Economy: Putting The DD Schedule And AA Schedule Together

Because asset markets adjust very quickly, the exchange rate jumps immediately from point 2 to point 3 on AA. The economy then moves to point 1 along AA as output rises to meet aggregate demand.

Monetary Policy

Fiscal Policy

Policies to Maintain Full Employment 1

Policies to Maintain Full Employment 2

Permanent Shifts in Monetary and Fiscal Policy A permanent policy shift affects not only the current value of the government ， s policy instrument but also the long-run exchange rate. A permanent policy shift affects not only the current value of the government ， s policy instrument but also the long-run exchange rate.

A Permanent increase in the Money Supply

Adjustment to a Permanent increase in the Money Supply

A Permanent Fiscal Expansion

Macroeconomic Policies and the Current Account

The J-Curve The J-curve describes the time Current account (in lag with which a real currency domestic output unite) depreciation improves the cur- rent account. Long-run effect of real depreci- ation on the 1 3 current account 2 Real depreciation End of J-curve takes place and J-curve begins Time

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