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Transcript
Policy in on open economy
The three major graphs for
fiscal or monetary policy are:
1. AD/AS
2. The domestic money market
3. The international money
market
P
AS
☺
F.E.
AD= C+I+G+NX
RGDP
loanable funds
r (federal funds rate)
S
r*
D
$Q*
Quantity ($ millions)
Equilibrium
Exchange Rate
Price
of $
S
P*
D
Q*
Quantity
How does the presence of the
international sector affect the
use of fiscal and monetary
policy?
P
AS
AD= C+I+G+NX
RGDPC F.E.
Rec. GAP
RGDP
To solve the Rec. Gap with
fiscal policy, we need to
increase government spending
or cut taxes to stimulate
consumption to increase AD to
AD’.
P
AS
RGDPC
AD’
AD= C+I+G+NX
F.E.
RGDP
Rec. GAP
When AD increases, consumers
buy more goods at higher prices
so the demand for money
increases which causes interest
rates to increase
loanable funds
r (federal funds rate)
S
r1
r*
D’
D
$Q*
Quantity ($ millions)
This increase in interest rates
causes the demand for the
dollar on the international
market to go up, and the supply
to go down. Thus, the dollar
appreciates in value
Price
of $
S’
S
D’
D
P*
P
Q
Quantity
The stronger dollar causes our
imports to increase and our
exports to fall, so NX decreases
which lowers AD’ to AD”.
P
AS
AD”
RGDPC
AD’
AD= C+I+G+NX
F.E.
RGDP
Rec. GAP
Fiscal policy is weakened by the
presence of the international
sector with floating exchange
rates.
The more integrated an
economy is with the world
market, the less effective fiscal
policy will become.
P
AS
AD
F.E. RGDPC
Infl. GAP
RGDP
To solve the Infl. Gap with fiscal
policy, we need to decrease
government spending or
increase taxes to cut
consumption to decrease AD to
AD’.
P
AS
AD=C+I+G+NX
AD’
F.E. RGDPC
Infl. GAP
RGDP
When AD decreases,
consumers buy fewer goods at
lower prices so the demand for
money decreases which causes
interest rates to decrease
loanable funds
r (federal funds rate)
S
r0
r1
D
D’
$Q*
Quantity ($ millions)
This decrease in interest rates
causes the demand for the
dollar on the international
market to go down, and the
supply to go up. Thus, the
dollar depreciates in value
Price
of $
S
S’
D
D’
P0
P1
Q
Quantity
The weaker dollar causes our
imports to decrease and our
exports to increase, so NX
increases which increases AD’
to AD”.
P
AS
AD”
AD=C+I+G+NX
AD’
F.E. RGDPC
Infl. GAP
RGDP
P
AS
AD= C+I+G+NX
RGDPC F.E.
Rec. GAP
RGDP
To solve the Rec. Gap with
monetary policy, the fed needs
to buy government bonds to
increase loanable funds to
increase the money supply to
lower interest rates which
increases investment and AD
loanable funds
r (federal funds rate)
S S’
r0
r1
D
$Q*
Quantity ($ millions)
P
AS
RGDPC
AD’
AD= C+I+G+NX
F.E.
RGDP
Rec. GAP
When AD increases, consumers
buy more goods at higher prices
so the demand for money
increases which causes interest
rates to increase
loanable funds
r (federal funds rate)
S S’
r0
r2
r1
D’
D
$Q*
Quantity ($ millions)
interest rates on net fall which
causes the demand for the
dollar on the international
market to fall, and the supply to
increase. Thus, the dollar
depreciates in value
Price
of $
S
S’
D
D’
P*
P
Q
Quantity
The weaker dollar causes our
imports to decrease and our
exports to increase, so NX
increases which increases AD’
to AD”.
P
AS
AD”
RGDPC
AD’
AD= C+I+G+NX
F.E.
RGDP
Rec. GAP
Monetary policy is strengthened
by the presence of the
international sector with floating
exchange rates.
The more integrated an
economy is with the world
market, the more effective
monetary policy will become.
P
AS
AD
F.E. RGDPC
Infl. GAP
RGDP
To solve the Infl. Gap with
monetary policy, the fed needs
to sell government bonds to
lower loans and the money
supply to raise interest rates to
lower investment spending and
decrease AD to AD’.
loanable funds
r (federal funds rate)
S’ S
r1
r0
D’
$Q*
Quantity ($ millions)
P
AS
AD=C+I+G+NX
AD’
F.E. RGDPC
Infl. GAP
RGDP
When AD decreases,
consumers buy fewer goods at
lower prices so the demand for
money decreases which causes
interest rates to decrease
loanable funds
r (federal funds rate)
S’ S
r1
r2
r0
D
D’
$Q*
Quantity ($ millions)
interest rates on net increase
which causes the demand for
the dollar on the international
market to go up, and the supply
to go down. Thus, the dollar
appreciates in value
Price
of $
S’
S
D’
D
P1
P0
Q
Quantity
The stronger dollar causes our
imports to increase and our
exports to decrease, so NX
decreases which decreases AD’
to AD”.
P
AS
AD”
AD=C+I+G+NX
AD’
F.E. RGDPC
Infl. GAP
RGDP
Because policy makers know
that the AD” is coming they will
do less monetary policy and
more fiscal policy going from AD
to AD’