The Open Economy Revisited Flashcards
Key assumption is that
r=r* otherwise everyone will put their money into NZ as they
can control the world’s interest rate
Now AD also includes NX(e) but investment will not change – so only variable is
real
exchange rate
Money supply does not include the _____ so increasing _____ will have no effect on the exchange rate – so it is perfectly _____
exchange rate, money
supply, inelastic
increasing money
supply will have no effect on the ______. so it is perfectly _____
exchange rate, inelastic
You can lower the OCR to increase the ______
money supply
Increase in OCR will shift the ___ to the right creating _____and so the exchange rate will fall increasing the ____.
LM, excess supply of currency, NX
If there is a fiscal policy to increase government spending
this will shift the IS curve
to the right – but will not change Y as exchange rate will be higher so NX will fall
An expansionary monetary policy means that aggregate world demand does not _____ – consumers switch from ________ – so it is at the expense
of the abroad _____
Increase, foreign to domestic goods, output
If a trade policy is introduced to put tariffs on imports
– this will mean that the IS
curve will shift to the right – but Y will not increase unless the reserve bank
cooperates to increase money supply – and so this will just lead to higher exchange
rate
Fixed exchange rate
when you change money supply in order to keep the exchange
rate at a certain level
So, if government spending increases IS will shift right
but LM will also shift right to
maintain the exchange rate – this can mean that Y will increase
Fixed exchange rate makes monetary policy totally ineffective
as it has to
constantly adjust to maintain the exchange rate
If the world interest rises this will lower the investment
this will lead to a
depreciation of the exchange rate as IS shifts left
In the China/USA Trade War the TFP declines because you are not using the
cheapest inputs – and this means that Y falls due to fall in A in AKaL1-a
and this would
mean that world interest will increase
In the long run we will always come back to
YBAR
Ø If the reserve bank changes the OCR to increase money supply – this will put
Y > YBAR
Y > YBAR
will mean that prices will rise – this will lower real money supply – which will
lower the real money demand – causing the LM to shift back to the original
Can the reserve bank affect the NX and exchange rate by changing the OCR?
short
run yes – long run no
There is a country risk
– that borrowers will default due to political/economic turmoil – lenders require higher interest to compensate risk
Expected exchange rate changes – if the exchange rate falls then borrowers will have
to pay
higher interest to compensate for the fall
r = r* + θ
which represents the risk premium
Y =
C + I (r* + θ) + G
+ NX
M/P=
=L (r* + θ, Y)
If theta increases this will mean that
interest rates rise so investment falls – and
IS will shift the left
so money demand falls and LM will shift the right
Deriving the AD curve
we use the real exchange rate instead of nominal as
before we assumed prices are constant – now they are variable
