ERM Flashcards
Can you draw me monetary expansion under a fixed ER
Authorities have to buy or sell currency when in excess supply or demand to stop appreciation or depreciation. When they sell, reserves fall to prevent depreciation. BOP deficit. Purchase back of domestic money supply reduces excess money supply. AD shifts back to AD1. Downward pressure on price level, back to P1
Can you draw me what happens with depreciation on a currency
Domestic goods more comp, s1 to s2. Increase demand for domestic currency due to goods being more comp, md1 to md2. M2 exceeds m1. BOP surplus prevent appreciation by purchasing foreign currency with domestic base, increases reserves. Ad1 to Ad2. Pushes up prices til PPP restored at P2. Ms=md again. BOP back in equilibrium
Monetary expansion under floating ER
No BOp deficit or surplus, authorities do not intervene to purchase or sell currency. No change in reserves. Rise in money stock m1 to m2. AD to AD2. Y2>Y1. Depreciation of ER due to excess demand for goods and services. PL rises, increase MD1 to MD2.
Increase income under fixed ER
Only effects BOP by influencing money demand. Shift AS right to AS2. Md1 up to md2. M2>m1. Reduced expenditure on domestic and foreign goods. Fall in domestic price level p1 to p2. Current and capital account move into surplus. Purchase foreign currency, rise in reserves and domestic money supply. Shift AD1 to AD2. PPP back towards P1.
Increase income floating ER
Increase transactions demand for money, excess supply of goods y2>y1 at p1. Domestic price level falls from P1 to P2. Exchange rate appreciates from S1 to S2 with lowered price level P2. Domestic money supply unchanged.
Increase in foreign prices under fixed ER
PPP line swivels upwards to PPP2. At S1 there’s a rise in domestic price level to P2. Reduced consumption of foreign goods, BOP surplus increase demand for domestic currency. Shift Md1 up to Md2. Authorities purchase foreign currencies. Reserves rise from R1 to R2 and M1 to M2. AD moves up to AD2, pushing prices up to P2, PPP restored.
Increase in foreign prices under floating ER
PPP swivels up to PPP2. Comp advantage offset by appreciation of currency from S1 to s2 (shift left) to maintain PPP at P1. Domestic PL and AD and output unaffected by the foreign price shock. Avoids imported inflation/deflation. Pursue and independent monetary policy.
