Download Open economy macroeconomics

Chapter 29
Open economy macroeconomics
David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,
9th Edition, McGraw-Hill, 2008
PowerPoint presentation by Alex Tackie and Damian Ward
©The McGraw-Hill Companies, 2008
Open economy macroeconomics
• … is the study of economies in which
international transactions play a
significant role
– international considerations are especially
important for open economies like the UK,
Germany or the Netherlands
• Domestic macroeconomic policy in such
countries cannot ignore the influence of
the rest of the world
– especially via the exchange rate.
©The McGraw-Hill Companies, 2008
Floating Exchange Rate and
Monetary Policy
Central bank increases money supply and decreases the interest rate.
İnterest
rate
P
MS2 MS1
r1
P1
r2
AD2
MD
M
AD1
Y1
Y2
A decrease in interest rate increases the demand and
output.
3
Y
©The McGraw-Hill Companies, 2008
Floating Exchange Rate and
Monetary Policy
• Monetary Policy is Effective under
Floating Exchange rate.
• Increase in MS →Decrease in r.
– C and I increases
– NX increases because the devaluation of
the exchange rate.
• Increases in demad and output.
4
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Fixed Exchange Rate and
Fiscal Policy
The
government
can use an
expansionary
fiscal policy to
increase the
demand and
the output.
P
AD3
AD2
AD1
P1
İncrease in G
Y1
5
Y2
Y3
Y
©The McGraw-Hill Companies, 2008
Fixed Exchange Rate and
Fiscal Policy
• When (G) increases,
– National output increases.
– Interest rate will also increase,
– There will be capital inflow
– The central bank increases the money
supply to keep the exchange rate constant.
– The interest rate will return to the original
value. In the meantime the output will
increase and a short-term economic boom
will be experienced.
6
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Crises in Greece
• Greece cannot apply its monetary policy
because it is in the Euro area.
• Greece cannot apply its fiscal policy because
the budget deficit is already very high and the
country is likely to default.
• The only policy left is to decrease prices. They
will be more competitive this way and will be
able to export. To decrease the price level, the
labor costs should decrease.
7
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