1、Chapter 3 Macroeconomic policy in an open economy3.1 The problem of internal and external balanceMuch of the 1950s and 1960s literature was concerned with how the authorities might simultaneously achieve both internal and external balance.Figure 3.1 The Swan diagramFigure 3.2 Equilibrium of the mode
2、l Figure 3.3 Surplus(a)and deficit(b)in the balance of paymentsInternal and external balance under fixed exchange ratesA situation of fixed exchange rates and unemployment is depicted in figure 3.4.Figure 3.4 Internal and external balance under a fixed exchange rateInternal and external balance unde
3、r floating exchange ratesFigure 3.5 illustrates the case of monetary expansion under floating exchange rates.Figure 3.5 A monetary expansion under floating exchange ratesFiscal expansion under floating exchange ratesThe effects of a fiscal expansion on the exchange rate under floating rates depend c
4、rucially upon the slope of the BP schedule relative to the LM schedule.Figure 3.6 Case 1:fiscal expansion under floating exchange ratesFigure 3.7 Case 2:fiscal expansion under floating exchange rates A small open economy with perfect capital mobilityThe model assumes a small country facing perfect c
5、apital mobility.Any attempt to raise the domestic interest rate leads to a massive capital inflow to purchase domestic bonds pushing up the price of bonds until the interest rate returns to the world interest rate.Figure 3.8 Fixed exchange rates and perfect capital mobilityFigure 3.9 Floating exchan
6、ge rates and perfect capital mobility The principle of effective market classification Mundell(1968)suggested that what he called the principle of effective market classification should be used by economic policy-makers in conjunction with Tinbergens instruments-targets rule.Mundells principle state
7、d that Policies should be paired with the objectives on which they have the most influence.Figure 3.10 The assignment problem Limitations of the Mundell-Fleming model-The Marshall-Lerner condition-Interaction of stocks and flow-Neglect of long-run constraints-Wealth effects-Neglect of supply-side fa
8、ctors-Treatment of capital flows-Exchange-rate expectations-Flexibility of policy instruments 3.3 ConclusionsIn this chapter we have illustrated some important aspects concerning the conduct of economic policy in an open economy.Among the most important lessons for economic policy-makers is that the
9、y generally need as many independent policy instruments as they have targets.In the real world the achievement of internal and external balance will be far more difficult that our theoretical analysis has suggested.We have seen that the relative effectiveness of fiscal and monetary policy is very much dependent upon the choice of exchange-rate regime.Although the Mundell-Fleming model has many limitations it none the less focuses attention on the difficulties and dilemmas facing policy-makers in an open economy.
