chap 7 Flashcards
what happens when trade balance increase ? (in TB - real exchange rate graph )
- trade balance shift up , in relation to ER
Factors that shift LM curve (graph)
what is the shape of the IS curve ? ( line )
- It is curve is downward
- it illustrate the negative relationship between the interest rate I and output Y
Deriving LM curve
Shock to investment (investment graph)
Monetary policy under fixed exchange rate
Consumption Funtion Graph:
Two important observation about deriving the IS curve :
- In an open economy , the lower interest rates stimulates demand through the traditional closed- economy investment channel and through trade balance.
- The trade balance effect occurs because lower interest rates cause a nominal depreciation ( a real depreciation in the short run), which stimulates external demand.
Formula for goods market equilibrium :
Y = C (Y-T~) + I(i) + G~ + TB ( EP~ / P~* , Y - T~ , Y* - T~*)
C (Y-T~) : consumption function ( Keynesian)
I(i) : investment function (relate to interest rate)
G~: government consumption ( g = taxes , no social program)
TB ( EP~ / P~* , Y - T~ , Y* - T~*) : trade balance function ( increasing function , decreasing function , increasing function )
Formula for Expected real interest rate “re” :
re = i - Pie
I : interest rate
Pie : inflation rate
“re”: Expected real interest rate re is the cost of investment
Liquidity Trap
Formula for aggregate demand :
D = C + I + G +TB
C: consumption,
I : investment
g : government
tb: trade balances
What a general equilibrium market needs?
It require equilibrium in all markets :
- Goods markets
- Money Market
- Forex market
Who and How stabilization policies can be used ?
- By authorities, they will try to keep the economy at full employment level output
What policymakers should do if the economy is hit by a temporary adverse shock ?
- They should use expansionary monetary policies to prevent deep recession
- Conversely, of the economy is push by a shock above its full employment level , contractionary policies could tame the boom
Poland and Lavia (policies differences)
formula of supply : (fallowing previous assumptions of tb and GNI = GDP )
Supply = GDP = Y
Y : gross national income (GNI)
what is the meaning of “ crowding out” ?
- It is the fiscal expansion impact where the increase in government spending is offset by decline in private spending
Responses to Policies Shock in the IS-LM-FX
what happens when household decide to consume more ? (in consumption - disposable income graph )
- the consumption function shift up
Factors that shift the IS curve : Demand curve D (shift up) IS curve shift right
- Rise in government spending “G”
- Fall in taxes “T”
- Fall in the FOREIGN interest rate “I*”
- Rise in the FUTURE nominal exchange rate “ER”
- Rise in foreign prices “P*”
- Fall in home prices “P”
- Any shift up in the consumption function “C”
- Any shift up in the investment function “I”
- Any shift up in the trade balance function “TB”
Deriving IS curve (graph)
what is a mayor assumption about the government ? (in this model and specific class )
- that the G = T , government is equal to taxes - ignoring all transfer programs (for simplicity)
Summary of reasons for demand curve D shifts up : (increasing demand at any given level of output ) (and the opposite)
- Rise in government spending “G”
- Fall in taxes “T”
- Fall in the home interest rate “i”
- Rise in the nominal exchange rate “ER”
- Rise in foreign prices “P*”
- Fall in home prices “P”
- Any shift up in the consumption function “C”
- Any shift up in the investment function “I”
- Any shift up in the trade balance function “TB”
What contain the LM curve ?
- The set of combinations of Y and I that ensure equilibrium
what events fallow after a TEMPORARY MONETARY EXPANSION (under fixed ER) ?
- It is impossible to undertake because fixing the ER means giving up monetary policy autonomy
- Trilemma problem
what happens when firms decide to invest more ? (in the interest rate - investment graph)
- the investment function shift right
Money market formula :
M/P~ = Y x L(i)
M/P~ : Real money supply
Y x L(i) : real money demand
P~: price level assuming sticky currency
What investment function do ?
It relate the quantity of investment to the level of expected real interest rate, which equal the nominal interest rate “I”
- When we assume that inflation is zero , the investment slope is downward
Key assumptions for IS-LM-FX model :
- The economy start in long run equilibrium , considering policies changes in home economy (assuming no change in foreign economic conditions )
- The home economy is subject to sticky prices
- also , forex market operates freely and unrestricted by capital controls - exchange rates only determined by market forces
Factors that shift the LM curve
- Rise in nominal money supply M
- Any shift left in the money demand function
Uncovered interest parity (UIP) equation :
i=I* + ( (Ee/E) - 1 )
I: domestic interest rate (domestic return)
I*: foreign interest rate
( (Ee/E) - 1 ): Expected rate of depreciation of domestic currency
I* + ( (Ee/E) - 1 ) : Expected foreign return
What via use fiscal policies ? What via use monetary policies ?
- Changes in spending or taxes = Changes in money supply
what events fallow “directly” after a TEMPORAL FISCAL EXPANSION (under fix ER) ?
It raise output by a considerable amount
Fiscal policy under fixed exchange rate
(TEMPORARY FISCAL EXPANSION)
what are the consequences of a “ fiscal expansion crowding out “?
- It raise interest rate (push investment)
- decrease net export ( by causing ER to appreciate )
IS-LM-FX model
Shock to trade balances Graph
what events fallow “directly” after a FISCAL EXPANSION (under floating ER) ?
- Raise output HOME
- Raise interest rate
- Appreciation of ER
- Decrease trade balances
Fiscal Policy under Fix Exchange Rate
The rigth time for austerity
Investment funtion graph
Shock to consumption (graph)
what the IS equilibrium shows ?
- It shows the combinations of output “Y” and the interests rate “i” for which the goods and forex ,market are in equilibrium
what events fallow “indirectly” after a FISCAL EXPANSION (under floating ER) ?
- Crowding out investment and export
- Limits the rise of output
Fiscal Policy under floting Exchange rate
Monetary Policy under floting exchange rate
Fiscal Polcies under fixed (EFFECTS)
Trade balance graph
Trade Balances Graph
What is the Keynesian consumption function ?
- A model of aggregate private consumption in relation to household consumption “C” to disposable income “Yd” C = C ( Y - T~) C: consumption Y : disposable income T ~ : taxes
what events fallow after a TEMPORARY MONETARY EXPANSION (under flowing ER) ?
- Raises output HOME
- Lowers interest rate
- Depreciation of ER
The goods market Equilibirum and the keynesian cross: (graph)
