Lesson 8 Flashcards
Temporary Change in Monetary and Fiscal Policy
in the SR output is variable but Governments can use stabilization policies to offset the impact of the demand shocks
Limit to Monetary Policy
Zero lower bound (interest rates can only go to zero) which implies that E can only go so high
Emax=Ee/(1-R*) where R = 0 [Liquidity Trap]
Permanent Changes in Monetary Policy
Different SR and LR effects than of a temporary policy change
Features of LR Equilibrium
Y=Yf E=Ee R=R* P if flexible and adjusts so that Ms/P = Md/P E adjusts so that AD = Yf
Permanent Changes in Monetary Policy
Leads to change in LR exchange rate
Changes in Monetary Policy
Temp - Ee does not change
Permanent - Ee changes in SR and matches E in LR
Short Run Effects
P-fixed
Ee instantly increases, shifts the AA up
Since P is fixed in SR Ms increase means a decrease in R
Now R
Long Run Effects
Yf
Pass through = 1
Nominal = Real
Pass through < 1
[Incomplete]
Nominal > Real
Import Prices
E x P*
Permanent increase in Ms
Larger SR increase in Y due to an additional rightward shift of AA
When the real exchange rate (q =E∙P*/P) rises the prices of foreign products rise relative to the prices of domestic products, giving rise to the following three effects
Exports bought rises (Ex up)
Imports bought falls (Im down)
Value of imports rises (P* more expensive) (Im up)
Marshall-Lerner condition
the volume effects outweigh the value effect is a valid one if export and import volumes are sufficiently price elastic with respect to a change in the real exchange rate [confirmed by empirical evidence]
The J Curve
after a nominal and real depreciation the current account balance (CA) first decreases as the value of imports rises, and then gradually increases as the volume effects begins to dominate the value effect
We found that temporary changes in monetary and fiscal policies could be used to stabilize the levels of demand and output at their full-employment level, by offsetting the impact of demand shocks.
We found that temporary changes in monetary and fiscal policies could be used to stabilize the levels of demand and output at their full-employment level, by offsetting the impact of demand shocks.
A permanent increase in money supply was found to have a more expansionary short-run impact on output than the same-sized temporary change in money supply. However, in the long-run a permanent increase in money supply has no effect on output and results in increases in the price level and nominal exchange rate which are proportionate to the increase in money supply.
We then analysed the effects of a permanent increase in government purchases and found that it had no short-run or long-run impact on the level of output.
Incomplete pass-through reduces the impact of a nominal depreciation on the current account balance
True
Under flexible exchange rates, a temporary increase in domestic money supply will
shift the AA curve up or to the right with no shift in the DD curve and increase both equilibrium output (Y) and the equilibrium exchange rate (E)
Under flexible exchange rates, a temporary increase in government purchases increases the level of output which leads to an increase in the interest rate, and a decrease in the exchange rate.
True
Under flexible exchange rates, a permanent increase in the money supply will cause a____________ SHORT-RUN increase in equilibrium output (Y) than would a purely temporary increase in money supply (of the same size) because, compared to the purely temporary increase, the permanent increase in money supply causes a______________
larger; larger rightward shift of the AA curve as the expected exchange rate rises
AA-DD Model
AA - downward sloping
DD - upward sloping
Assume an economy initially in long-run equilibrium at full employment operating with flexible exchange rates. The government implements a permanent increase in government purchases. Assuming that the expected exchange rate adjusts instantly to its new long-run equilibrium level, we can predict that this permanent increase in G will
shift the DD curve to the right shift the AA curve down or to the left Results equilibrium output (Y) unchanged decreasing the equilibrium exchange rate (E)
