Session 22 How Does the Open Macro-economy Work?

National Macro-economic Performance Goals  Internal Balance  Full employment, or an acceptably low unemployment rate  Price stability, or an acceptably low inflation rate  External balance  Sustainable composition of the country’s balance of payments with the rest of the world

A Basic Framework for Macro-economic Analysis  Domestic production depends on aggregate demand. GDP = C + I + G + (X – M) Aggregate Expenditure = C + I + G + (X – M) Aggregate Demand = C + I + G + (X – M) Inflation =

 Trade depends on income.

A More Complete Framework : Three Markets Mundell – Fleming Model  The Domestic Product Market  The Money Market  The Foreign Exchange Market (Balance of Payment)

The Investment – Saving Curve (Product Market) Some Exogenous shocks that shift the IS curve up (or to the right) IS2 up An increase in government spending or a tax cut An improved customer expectations about the future The shift in the tastes of foreign customers toward the country’s products.

The Liquidity – Money Curve (Money Market) Some Exogenous shocks that shift the LM curve down (or to the right) LM2 Down An increase in government spending or a tax cut A decrease in average price level ( i.e., due to a decline in oil prices) The introduction of credit cards.

The Foreign Exchange Market (or Balance of Payment) Some Exogenous shocks that shift the FE curve down (or to the right) FE2 Down An increase in exports The country’s currency value decrease (i.e., from ฿ 25/ $ 1 to ฿ 50/ $ 1) Inflow > Outflow (Export > Import) A decrease in imports Inflow < Outflow (Export < Import) A decrease in foreign interest rate A increase in the expected rate of appreciation of the country’s currency

฿ 25/ $ 1 More inflow dollars Based on the expectation, the dollar holders could make the profit as follows ฿ 20/ $ 1 the expected rate of appreciation $ 1 ฿ 25 Now ฿ 5 (profit) ฿ 20 = $1 (cost) $ 1 Future As a result of the expected rate of appreciation, the following happens More demand for baht The value of baht will decrease ( ฿ 25/ $ 1 to ฿ 30/ $1)

Macro-economic Policies