L15 - Policy Options In Open Economies

Question 1

We’ve established monetary policy in an open economy with a floating e is VERY EFFECTIVE. What about in a closed economy? (1)

Answer 1

Not as much! As could allow i to fall, given no capital flows and no e to change

Question 2

Ok a fixed-price small open economy monetary policy works

Answer 2

EXCLUSIVELY through an exchange rate channel

Question 3

What about fiscal policy effectiveness with floating e? (2)

Note: ONLY WITH ASSUMPTION OF FIXED M

Answer 3

Not at all effective in changing Y as that is entirely determined in money market, and change to goods has no effect

Y unchanged, like the Classics result only here it’s because if we wanted to increase it would increase money supply, whereas in Classical would have to increase FOP

One-for-one rise in G results in fall in NX due to appreciation having offsetting effects

Question 4

What I’d get rid of assumption of fixed M (3)

BUT NOTE: M-F assume CB holds M constant

Answer 4

CB accommodated higher G by making the free decision to expand M

Question 5

Monetary expansion with fixed ē (think of IS/LM in (e, Y) space)

Answer 5

Would put downward-pressure on e, inconsistent with peg, people would want to buy foreign currency and sell domestic one so that they can buy domestic when its devalued, would have to buy domestic currency which takes money out of economy

Question 6

Fiscal policy - can it work with fixed ē?

Answer 6

Yes-
Raises expansion by the fiscal multiplier, look at (e, Y) space

Induced expansion on M prevents offset from higher r

Question 7

Is there a monetary-fiscal conflict in fiscal policy with ē? Is what determines outcomes and what does that leave us with?

Answer 7

No freedom in M, assuming G set first

Goods market (IS) completely determines outcomes, if Y rises M must rise to maintain eqm

Question 8

Way to have fixed ē and active MP?

What does it imply for NCF?

Answer 8

Yes! Capital movement restrictions

Means no longer infinitely elastic

Question 9

DEF: impossible trinity

Answer 9

Countries can have only two of these three options:

1. A fixed ē
2. Capital flows
3. Independent monetary policy/monetary activism

Question 10

Why bother pegging?

Answer 10

1. Trade effects: more stable e-> more integration (welfare-improving: specialisation, comparative advantage, LRAS rises)

e risk allows for 10-15% price fluctuations, domestic producers allowed to provide goods to rest of world at stable competitive price-> esp good for commodity producers

2. Price stability: fixed ē as ‘commitment decide, wrt pi

Question 11

Is the evidence for the two previous arguments convincing?

Answer 11

1. Not so much

2. Yes - institutional credobiloty imported from abroad, sentiment for inflation expectations