1、 CHAPTER 20CHAPTER20 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier BlanchardOutput,the Output,the Interest Rate,and Interest Rate,and the Exchange Ratethe Exchange RatePrepared by:Fernando Quijano and Yvonn Quijano 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier
2、 Blanchard2Output,the Interest Rate,and the Exchange RateThe model developed in this chapter is an extension of the open economy IS-LM model,known as the Mundell-Fleming model.The main questions we try to solve are:What determines the exchange rate?How can policy makers affect exchange rates?2006 Pr
3、entice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard3Equilibrium in the Goods MarketEquilibrium in the goods market can be described by the following equations:Y C Y TI Y rG IM YX Y()(,)(,)/(,)*()(,)(,)(,)NX Y YX YIM Y(,)(,)(,)/*YC YTI Y rGNX Y Y()(,)(,)*()(,)(,)20-1 2006 Prentice Ha
4、ll Business Publishing Macroeconomics,4/e Olivier Blanchard4Equilibrium in the Goods Market Consumption C depends positively on disposable income Y-T.Investment I depends positively on output Y,and negatively on the real interest rate r.Government spending G is taken as given.The quantity of imports
5、 IM depends positively on both output Y and the real exchange rate .Exports X depend positively on foreign output Y*and negatively on the real exchange rate .2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard5Equilibrium in the Goods MarketThe main implication of this equati
6、on is that both the real interest rate and the real exchange rate affect demand and,in turn,equilibrium output:An increase in the real interest rate leads to a decrease in investment spending,and to a decrease in the demand for domestic goods.An increase in the real exchange rate leads to a shift in
7、 demand toward foreign goods,and to a decrease in net exports.YC YTI Y rGNX Y Y()(,)(,)*()(,)(,)2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard6Equilibrium in the Goods MarketIn this chapter we make two simplifications:Both the domestic and the foreign price levels are gi
8、ven;thus,the nominal and the real exchange rate move together:PPE*1There is no inflation,neither actual nor expected.ei0,so rThen,the equilibrium condition becomes:YC YTI Y rGNX Y YE()(,)(,)*()(,)(,)2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard7Equilibrium in Financial
9、markets20-2Now that we look at a financially open economy,we must also take into account the fact that people have a choice between domestic bonds and foreign bonds.2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard8Money Versus BondsWe wrote the condition that the supply of
10、 money be equal to the demand for money as:We can use this equation to think about the determination of the nominal interest rate in an open economy.MPYL i()2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard9Domestic Bonds Versus Foreign BondsWhat combination of domestic and
11、 foreign bonds should financial investors choose in order to maximize expected returns?()()*111iiEEtttetThe left side gives the return,in terms of domestic currency.The right side gives the expected return,also in terms of domestic currency.In equilibrium,the two expected returns must be equal.2006
12、Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard10Domestic Bonds Versus Foreign BondsIf the expected future exchange rate is given,then:EiiEtttte111*The current exchange rate isEiiEe11*()()*111iiEEtttet 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard
13、11Domestic Bonds Versus Foreign BondsAn increase in the U.S.interest rate,say,after a monetary contraction,will cause the U.S.interest rate to increase,and the demand for U.S.bonds to rise.As investors switch from foreign currency to dollars,the dollar appreciates.The more the dollar appreciates,the
14、 more investors expect it to depreciate in the future.The initial dollar appreciation must be such that the expected future depreciation compensates for the increase in the U.S.interest rate.When this is the case,investors are again indifferent and equilibrium prevails.2006 Prentice Hall Business Pu
15、blishing Macroeconomics,4/e Olivier Blanchard12Domestic Bonds Versus Foreign BondsThe Relation Between the Interest Rate and the Exchange Rate Implied by Interest ParityFigure 20-1 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard13Putting Goods andFinancial Markets Togethe
16、rGoods-market equilibrium implies that output depends,among other factors,on the interest rate and the exchange rate.YC YTI Y iGNX Y YE()(,)(,)*20-3 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard14Putting Goods andFinancial Markets TogetherThe interest rate is determined
17、 by the equality of money supply and money demand:MPYL i()The interest-parity condition implies a negative relation between the domestic interest rate and the exchange rate:EiiEe11*iE iE 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard15Putting Goods andFinancial Markets T
18、ogetherThe open-economy versions of the IS and LM relations are:Changes in the interest rate affect the economy directly through investment,indirectly through the exchange rate.IS Y C Y TI Y iG NX Y YiiEe:()(,),*11LMMPYL i:()2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard
19、16Putting Goods andFinancial Markets TogetherThe IS-LM Model in the Open EconomyFigure 20-2 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard17The Effects of Policyin an Open EconomyThe Effects of an Increase in Government SpendingThe increase in government spending shifts
20、the IS curve to the right.It shifts neither the LM curve nor the interest-parity curve.20-4Figure 20-3 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard18The Effects of Policyin an Open EconomyCan we tell what happens to the various components of demand for money when the g
21、overnment increases spending:Consumption and government spending both go up.The effect of government spending on investment was ambiguous in the closed economy,it remains ambiguous in the open economy.Both the increase in output and the appreciation combine to decrease net exports.2006 Prentice Hall
22、 Business Publishing Macroeconomics,4/e Olivier Blanchard19The Effects of Monetary Policyin an Open EconomyThe Effects of a Monetary ContractionA monetary contraction shifts the LM curve up.It shifts neither the IS curve nor the interest-parity curve.Figure 20-4 2006 Prentice Hall Business Publishin
23、g Macroeconomics,4/e Olivier Blanchard20Table 1 The Emergence of Large U.S.Budget Deficits,1980-198419801981198219831984Spending22.022.824.025.023.7Revenues20.220.820.519.419.2 Personal taxes9.49.69.98.88.2 Corporate taxes2.62.31.61.62.0Budget surplus(-:deficit)1.8 2.0 3.5 5.6 4.5Numbers are for fis
24、cal years,which start in October of the previous calendar year.All numbers are expressed as a percentage of GDP.Monetary Contraction,and Monetary Contraction,and Fiscal Expansion:The United Fiscal Expansion:The United States in the Early 1980sStates in the Early 1980s 2006 Prentice Hall Business Pub
25、lishing Macroeconomics,4/e Olivier Blanchard21Supply sidersa group of economists who argued that a cut in tax rates would boost economic activity.High output growth and dollar appreciation during the early 1980s resulted in an increase in the trade deficit.A higher trade deficit,combined with a larg
26、e budget deficit,became know as the twin deficits of the 1980s.Monetary Contraction,and Monetary Contraction,and Fiscal Expansion:The United Fiscal Expansion:The United States in the Early 1980sStates in the Early 1980s 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard22Tab
27、le 2Major U.S.Macroeconomic Variables,1980-198419801981198219831984GDP Growth(%)0.51.8 2.23.96.2Unemployment rate(%)7.17.69.79.67.5Inflation(CPI)(%)12.58.93.83.83.9Interest rate(nominal)(%)11.514.010.68.69.6(real)(%)2.54.96.05.15.9Real exchange rate85 101111117129Trade surplus(:deficit)(%of GDP)-0.5
28、-0.4-0.6-1.5-2.7Inflation:Rate of change of the CPI.The nominal interest rate is the three-month T-bill rate.The real interest rate is equal to the nominal rate minus the forecast of inflation by DRI,a private forecasting firm.The real exchange rate is the trade-weighted real exchange rate,normalize
29、d so that 1973=100Monetary Contraction,and Fiscal Monetary Contraction,and Fiscal Expansion:The United States Expansion:The United States in the Early 1980sin the Early 1980s 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard23Fixed Exchange RatesCentral banks act under impl
30、icit and explicit exchange-rate targets and use monetary policy to achieve those targets.20-5 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard24Pegs,Crawling Pegs,Bonds,the EMS,and the EuroSome countries operate under fixed exchange rates.These countries maintain a fixed e
31、xchange rate in terms of some foreign currency.Some peg their currency to the dollar.Some countries operate under a crawling peg.These countries typically have inflation rates that exceed the U.S.inflation rate.2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard25Pegs,Crawlin
32、g Pegs,Bonds,the EMS,and the EuroSome countries maintain their bilateral exchange rates within some bands.The most prominent example is the European Monetary System(EMS).Under the EMS rules,member countries agreed to maintain their exchange rate vis-vis the other currencies in the system within narr
33、ow limits or bands around a central parity.Some countries moved further,agreeing to adopt a common currency,the Euro,in effect,adopting a“fixed exchange rate.”2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard26Pegging the Exchange Rate,and Monetary ControlThe interest parit
34、y condition is:()()*111iiEEtttetPegging the exchange rate turns the interest parity relation into:()()*11iiiitttt 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard27Pegging the Exchange Rate,and Monetary ControlIncreases in the domestic demand for money must be matched by i
35、ncreases in the supply of money in order to maintain the interest rate constant,so that the following condition holds:In words:Under a fixed exchange rate and perfect capital mobility,the domestic interest rate must be equal to the foreign interest rate.MPYL i()*2006 Prentice Hall Business Publishin
36、g Macroeconomics,4/e Olivier Blanchard28Fiscal Policy UnderFixed Exchange RatesThe Effects of a Fiscal Expansion Under Fixed Exchange RatesThe central bank must accommodate the resulting increase in the demand for money.Figure 20-5 2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Bl
37、anchard29Fiscal Policy UnderFixed Exchange RatesThere are a number of reasons why countries choosing to fix its interest rate appears to be a bad idea:By fixing the exchange rate,a country gives up a powerful tool for correcting trade imbalances or changing the level of economic activity.By committi
38、ng to a particular exchange rate,a country also gives up control of its interest rate,and they must match movements in the foreign interest rate risking unwanted effects on its own activity.2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard30Fiscal Policy UnderFixed Exchange
39、 RatesThere are a number of reasons why countries choosing to fix its interest rate appears to be a bad idea:Although the country retains control of fiscal policy,one policy instrument is not enough.A country that wants to decrease its budget deficit cannot,under fixed exchange rates,use monetary po
40、licy to offset the contractionary effect of its fiscal policy on output.2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard31German Unification,German Unification,Interest Rates,and the EMSInterest Rates,and the EMSTable 1German Unification,Interest Rates,and Output Growth:Ge
41、rmany,France,and Belgium,1990-1992Nominal Interest Rates(%)Inflation(%)199019911992199019911992Germany8.59.29.52.73.74.7France10.39.610.32.93.02.4Belgium9.69.49.42.92.72.4Real Interest Rates(%)GDP Growth(%)199019911992199019911992Germany5.75.54.85.74.52.1France7.46.67.92.50.71.4Belgium6.76.77.03.32.
42、10.8The nominal interest rate is the short-term nominal interest rate.The real interest rate is the realized real interest rate over the year that is,the nominal interest rate minus actual inflation over the year.All rates are annual.2006 Prentice Hall Business Publishing Macroeconomics,4/e Olivier Blanchard32Key Terms Mundell-Fleming model supply siders twin deficits peg crawling peg European Monetary System(EMS)bands central parity Euro
