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Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Reduced volatility of aggregate demand may also be desirable Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Reduced volatility of aggregate demand may also be desirable Volatile prices makes planning for the future more difficult Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Reduced volatility of aggregate demand may also be desirable Volatile prices makes planning for the future more difficult Imposes a cost of adjusting prices, Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Reduced volatility of aggregate demand may also be desirable Volatile prices makes planning for the future more difficult Imposes a cost of adjusting prices, Arbitrarily redistributes income between lenders and borrowers Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Reduced volatility of aggregate demand may also be desirable Volatile prices makes planning for the future more difficult Imposes a cost of adjusting prices, Arbitrarily redistributes income between lenders and borrowers Example Full employment and price stability is harder/easier in an open economy? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal Balance Macroeconomic goals of producing at potential output at full employment Reduced volatility of aggregate demand may also be desirable Volatile prices makes planning for the future more difficult Imposes a cost of adjusting prices, Arbitrarily redistributes income between lenders and borrowers Example Full employment and price stability is harder/easier in an open economy? Answer: Much harder! Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. A large current account surplus can cause protectionist pressure Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. A large current account surplus can cause protectionist pressure Pressure on Japan in the 1980s and China in the 2000s Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. A large current account surplus can cause protectionist pressure Pressure on Japan in the 1980s and China in the 2000s Maintaining external balance means keeping the exchange rate competitive. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. A large current account surplus can cause protectionist pressure Pressure on Japan in the 1980s and China in the 2000s Maintaining external balance means keeping the exchange rate competitive. Managing reserves so a cushion always exists Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. A large current account surplus can cause protectionist pressure Pressure on Japan in the 1980s and China in the 2000s Maintaining external balance means keeping the exchange rate competitive. Managing reserves so a cushion always exists Example Are financial crises always bad? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance External balance A large current account deficit can make foreigners nervous Think cannot repay its debts and therefore make them stop lending Leads to financial crisis. A large current account surplus can cause protectionist pressure Pressure on Japan in the 1980s and China in the 2000s Maintaining external balance means keeping the exchange rate competitive. Managing reserves so a cushion always exists Example Are financial crises always bad? Answer: Yes, for the country involved, but it can help others. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Prices tended to adjust according the amount of gold circulating in an economy Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Prices tended to adjust according the amount of gold circulating in an economy Hume: Price specie flow mechanism is the adjustment of prices as gold (specie) flows into or out of a country Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Prices tended to adjust according the amount of gold circulating in an economy Hume: Price specie flow mechanism is the adjustment of prices as gold (specie) flows into or out of a country Caused prices to rise with a surplus and vice-versa Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Prices tended to adjust according the amount of gold circulating in an economy Hume: Price specie flow mechanism is the adjustment of prices as gold (specie) flows into or out of a country Caused prices to rise with a surplus and vice-versa Rules of the Game were to borrow (sell domestic assets) when gold reserves were low and vice-versa Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Prices tended to adjust according the amount of gold circulating in an economy Hume: Price specie flow mechanism is the adjustment of prices as gold (specie) flows into or out of a country Caused prices to rise with a surplus and vice-versa Rules of the Game were to borrow (sell domestic assets) when gold reserves were low and vice-versa Example Would central banks with increasing gold reserves play by the rules? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard from 1870-1914 and after 1918 Prevented flows of gold reserves (the balance of payments) from becoming too positive or too negative Prices tended to adjust according the amount of gold circulating in an economy Hume: Price specie flow mechanism is the adjustment of prices as gold (specie) flows into or out of a country Caused prices to rise with a surplus and vice-versa Rules of the Game were to borrow (sell domestic assets) when gold reserves were low and vice-versa Example Would central banks with increasing gold reserves play by the rules? Answer: No! There was no reason for them to do so... Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Fixed exchange rates against the U.S. dollar Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Fixed exchange rates against the U.S. dollar Fixed dollar price of gold ($35 per ounce). Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Fixed exchange rates against the U.S. dollar Fixed dollar price of gold ($35 per ounce). Also established Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Fixed exchange rates against the U.S. dollar Fixed dollar price of gold ($35 per ounce). Also established The International Monetary Fund Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Fixed exchange rates against the U.S. dollar Fixed dollar price of gold ($35 per ounce). Also established The International Monetary Fund The World Bank Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Gold Standard Ends Think of it is as uber-fixed exchange rates Monetary policy ineffective Did not work: supplies of gold fluctuated and not with economic activity In July 1944, 44 countries met agreed to Bretton Woods principles: Fixed exchange rates against the U.S. dollar Fixed dollar price of gold ($35 per ounce). Also established The International Monetary Fund The World Bank General Agreement on Trade and Tariffs (GATT)...predecessor WTO. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Loans were made from a fund paid for by members in gold and currencies. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Loans were made from a fund paid for by members in gold and currencies. Each country has a quota, which determined its contribution to the fund and the maximum amount it could borrow. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Loans were made from a fund paid for by members in gold and currencies. Each country has a quota, which determined its contribution to the fund and the maximum amount it could borrow. Large loans were made on IMF conditionality Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Loans were made from a fund paid for by members in gold and currencies. Each country has a quota, which determined its contribution to the fund and the maximum amount it could borrow. Large loans were made on IMF conditionality Devaluations ok if there was a Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Loans were made from a fund paid for by members in gold and currencies. Each country has a quota, which determined its contribution to the fund and the maximum amount it could borrow. Large loans were made on IMF conditionality Devaluations ok if there was a Example Why is the IMF callled the “lender of last resort” Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Designed to lend to countries with persistent balance of payments deficits Also to approve of devaluations. Loans were made from a fund paid for by members in gold and currencies. Each country has a quota, which determined its contribution to the fund and the maximum amount it could borrow. Large loans were made on IMF conditionality Devaluations ok if there was a Example Why is the IMF callled the “lender of last resort” Answer: Because no one else will loan the country mone Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Exchange rate volatility viewed as a source of economic instability Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Exchange rate volatility viewed as a source of economic instability Probably the other way around Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Exchange rate volatility viewed as a source of economic instability Probably the other way around IMF was believed to give countries enough flexibility to attain an external balance, Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Exchange rate volatility viewed as a source of economic instability Probably the other way around IMF was believed to give countries enough flexibility to attain an external balance, Also maintain an internal balance and stable exchange rates. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Exchange rate volatility viewed as a source of economic instability Probably the other way around IMF was believed to give countries enough flexibility to attain an external balance, Also maintain an internal balance and stable exchange rates. Example Why was the IMF despised in LDC? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance IMF Lots of volatility of exchange rates during 19181939 Caused by devaluations and the problems with of the gold standard Exchange rate volatility viewed as a source of economic instability Probably the other way around IMF was believed to give countries enough flexibility to attain an external balance, Also maintain an internal balance and stable exchange rates. Example Why was the IMF despised in LDC? Answer: Because it imposed fiscal discipline Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Could spark a financial crisis Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Could spark a financial crisis BWI supported capital controls Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Could spark a financial crisis BWI supported capital controls US benefited enormously...had reserve currency and effective monetary policy Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Could spark a financial crisis BWI supported capital controls US benefited enormously...had reserve currency and effective monetary policy No other country did! Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Could spark a financial crisis BWI supported capital controls US benefited enormously...had reserve currency and effective monetary policy No other country did! Example Why has favor shifted to the flexible exchange rate and open capital markets? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Hot money Wanted to avoid sudden changes in the financial account Could spark a financial crisis BWI supported capital controls US benefited enormously...had reserve currency and effective monetary policy No other country did! Example Why has favor shifted to the flexible exchange rate and open capital markets? Answer: Because volatility now seen as result of fiscal mismanagement, not a first cause! Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. The principal tools for external balance were borrowing from the IMF, Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. The principal tools for external balance were borrowing from the IMF, Restrictions on financial asset flows and infrequent changes in exchange rates Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. The principal tools for external balance were borrowing from the IMF, Restrictions on financial asset flows and infrequent changes in exchange rates But in general, fiscal policy can not attain both internal balance and external balance at the same time. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. The principal tools for external balance were borrowing from the IMF, Restrictions on financial asset flows and infrequent changes in exchange rates But in general, fiscal policy can not attain both internal balance and external balance at the same time. Gave rise to debt and debt crisis! Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. The principal tools for external balance were borrowing from the IMF, Restrictions on financial asset flows and infrequent changes in exchange rates But in general, fiscal policy can not attain both internal balance and external balance at the same time. Gave rise to debt and debt crisis! Example Why are Keynesian policies out of favor? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World The principal tool for internal balance was fiscal policy (government purchases or taxes) Followed Keynesian thinking the max. The principal tools for external balance were borrowing from the IMF, Restrictions on financial asset flows and infrequent changes in exchange rates But in general, fiscal policy can not attain both internal balance and external balance at the same time. Gave rise to debt and debt crisis! Example Why are Keynesian policies out of favor? Answer: Cause a bias toward building up debt. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Keynesian World Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Expansion leads to imports deficit for US and surplus for countries abroad: Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Expansion leads to imports deficit for US and surplus for countries abroad: Fed itself constrained in mon policies by obligation to redeem dollars for good: Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Expansion leads to imports deficit for US and surplus for countries abroad: Fed itself constrained in mon policies by obligation to redeem dollars for good: Official price of 35 per ounce pushed up if too many dollars created Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Expansion leads to imports deficit for US and surplus for countries abroad: Fed itself constrained in mon policies by obligation to redeem dollars for good: Official price of 35 per ounce pushed up if too many dollars created Became clear that govt would not sacrifice unemployment to maintain free trade at fixed exchange rates Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Expansion leads to imports deficit for US and surplus for countries abroad: Fed itself constrained in mon policies by obligation to redeem dollars for good: Official price of 35 per ounce pushed up if too many dollars created Became clear that govt would not sacrifice unemployment to maintain free trade at fixed exchange rates Interest rates became more unified and countries that wanted a different rate had to impose capital controls Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Fixed exchange rates were only an ideal High US monetary growth leads to dollar accumulation of foreign banks Expansion leads to imports deficit for US and surplus for countries abroad: Fed itself constrained in mon policies by obligation to redeem dollars for good: Official price of 35 per ounce pushed up if too many dollars created Became clear that govt would not sacrifice unemployment to maintain free trade at fixed exchange rates Interest rates became more unified and countries that wanted a different rate had to impose capital controls US monetary policy determined the supply of money in the world (more or less) Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Full employment AD: Y f − C (Y d + I + G + CA ) Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Full employment AD: Y f − C (Y d + I + G + CA ) CA = f (EP ∗ /P, Yf T ) with dCA /dE > 0 Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Full employment AD: Y f − C (Y d + I + G + CA ) CA = f (EP ∗ /P, Yf T ) with dCA /dE > 0 Policymakers tools: fiscal policy and exchange rate manipulation Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Full employment AD: Y f − C (Y d + I + G + CA ) CA = f (EP ∗ /P, Yf T ) with dCA /dE > 0 Policymakers tools: fiscal policy and exchange rate manipulation An increase in government purchases (or a decrease in taxes) increases aggregate demand and output above its full employment level. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Full employment AD: Y f − C (Y d + I + G + CA ) CA = f (EP ∗ /P, Yf T ) with dCA /dE > 0 Policymakers tools: fiscal policy and exchange rate manipulation An increase in government purchases (or a decrease in taxes) increases aggregate demand and output above its full employment level. To restore internal balance in the short run, a revaluation (a fall in E) must occur. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Internal and External Balance under BW Assume for simplicity that R = R ∗ and price levels are fixed Full employment AD: Y f − C (Y d + I + G + CA ) CA = f (EP ∗ /P, Yf T ) with dCA /dE > 0 Policymakers tools: fiscal policy and exchange rate manipulation An increase in government purchases (or a decrease in taxes) increases aggregate demand and output above its full employment level. To restore internal balance in the short run, a revaluation (a fall in E) must occur. Monetary policy not part of the picture Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Must have in mind a certain current account deficit. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Must have in mind a certain current account deficit. Example Is fiscal policy enough to bring about internal and external balance? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Must have in mind a certain current account deficit. Example Is fiscal policy enough to bring about internal and external balance? Answer: Acting alone, fiscal policy can attain either internal or external balance but only at the cost of increasing the economy’s distance from the goal that is sacrificed. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Must have in mind a certain current account deficit. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Must have in mind a certain current account deficit. Example Is fiscal policy enough to bring about internal and external balance? Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Four zones of economic discomfort XX and II curves divide the diagram in four regions. Zone: employment too high and building up reserves Use expenditure changing policy And expenditure switching policy Must have in mind a certain current account deficit. Example Is fiscal policy enough to bring about internal and external balance? Answer: Acting alone, fiscal policy can attain either internal or external balance but only at the cost of increasing the economy’s distance from the goal that is sacrificed. Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Model Y = c̄ + c (1 − t )Y + Ī − bR + G + qX − mY Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Model Y = c̄ + c (1 − t )Y + Ī − bR + G + qX − mY But under fixed exchange rates and perfect substitutability R = R∗ Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Model Y = c̄ + c (1 − t )Y + Ī − bR + G + qX − mY But under fixed exchange rates and perfect substitutability R = R∗ Hence Y = c̄ + Ī − bR + G + qX 1 − c (1 − t ) + m Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Calibration Table: SAM Firms Firms HH Savings Govt Foreign Total HH 160 Inv 20 Gov 30 For -10 0 10 30 0 200 10 30 200 200 20 Note: c=0.8, m=0.3, b=100, R = 0.5 Bill Gibson University of Vermont Total 200 200 20 30 0 Internal and External Balance Gold standard IMF Internal balance Calibration Example Calibrate a model to this SAM with fixed exchange rates Solution: In the base SAM q = 1, p = 1, E = 1 Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Calibration Example Calibrate a model to this SAM with fixed exchange rates Solution: In the base SAM q = 1, p = 1, E = 1 Consumption function: 160 = c̄ + 0.8(1 − 0.15)(200) → c̄ = 24 Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Calibration Example Calibrate a model to this SAM with fixed exchange rates Solution: In the base SAM q = 1, p = 1, E = 1 Consumption function: 160 = c̄ + 0.8(1 − 0.15)(200) → c̄ = 24 Import and export functions X − M = −10, M = mY = 0.3(200) → X = 50 Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Calibration Example Calibrate a model to this SAM with fixed exchange rates Solution: In the base SAM q = 1, p = 1, E = 1 Consumption function: 160 = c̄ + 0.8(1 − 0.15)(200) → c̄ = 24 Import and export functions X − M = −10, M = mY = 0.3(200) → X = 50 Investment function I = 20 = Ī − 100(0.05) → Ī = 25 Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Calibration Example Calibrate a model to this SAM with fixed exchange rates Solution: In the base SAM q = 1, p = 1, E = 1 Consumption function: 160 = c̄ + 0.8(1 − 0.15)(200) → c̄ = 24 Import and export functions X − M = −10, M = mY = 0.3(200) → X = 50 Investment function I = 20 = Ī − 100(0.05) → Ī = 25 Calibrated model Y = 20 + 0.68Y + 25 − 100R + 30 + 50Ep ∗ /p − 0.3Y Bill Gibson University of Vermont Internal and External Balance Gold standard IMF Internal balance Calibration Example Calibrate a model to this SAM with fixed exchange rates Solution: In the base SAM q = 1, p = 1, E = 1 Consumption function: 160 = c̄ + 0.8(1 − 0.15)(200) → c̄ = 24 Import and export functions X − M = −10, M = mY = 0.3(200) → X = 50 Investment function I = 20 = Ī − 100(0.05) → Ī = 25 Calibrated model Y = 20 + 0.68Y + 25 − 100R + 30 + 50Ep ∗ /p − 0.3Y Find internal and external balance with Y f = 225, R = 0.05 Bill Gibson University of Vermont
