W3P5 - Notebook LM Flashcards
What is the financial integration line in an open economy IS-LM model?
The financial integration line represents the equilibrium in the international bond market. It’s the locus of equilibria in the international bond market.
What are the conditions for general equilibrium in the open economy IS-LM model?
General equilibrium is achieved when the economy is simultaneously on the IS curve (goods market equilibrium), the LM curve (money market equilibrium), and the financial integration line (international bond market equilibrium)
What happens when the domestic interest rate is above the financial integration line?
When the domestic interest rate is above the financial integration line, the domestic currency appreciates.
What happens when the domestic interest rate is below the financial integration line?
When the domestic interest rate is below the financial integration line, the domestic currency depreciates.
What are the two extreme exchange rate regimes discussed in the lecture?
The two extreme exchange rate regimes are fixed exchange rates and flexible exchange rates.
How does a central bank operate under a fixed exchange rate regime?
Under a fixed exchange rate regime, the central bank intervenes to maintain a specific exchange rate. It adjusts the money supply to counteract pressure for the domestic currency to appreciate or depreciate.
How is the exchange rate determined under a flexible exchange rate regime?
Under a flexible exchange rate regime, the exchange rate is determined by the market forces of demand and supply.
How effective is monetary policy under a fixed exchange rate regime?
Monetary policy is ineffective under a fixed exchange rate regime. The central bank cannot independently increase the money supply because it must maintain the fixed exchange rate.
How effective is fiscal policy under a fixed exchange rate regime?
Fiscal policy is effective under a fixed exchange rate regime. An increase in government spending increases interest rates and the central bank accommodates this by increasing the money supply, which leads to an increase in output.
How effective is monetary policy under a flexible exchange rate regime?
Monetary policy is effective under a flexible exchange rate regime. An increase in the money supply lowers interest rates, causing currency depreciation, which increases net exports and output.
How effective is fiscal policy under a flexible exchange rate regime?
Fiscal policy is ineffective under a flexible exchange rate regime. An increase in government spending increases interest rates, causing currency appreciation, which decreases net exports. This offsets the initial increase in government spending, resulting in no change in output.
How does an appreciation of the domestic currency affect net exports?
An appreciation of the domestic currency reduces net exports by making domestic goods more expensive and foreign goods cheaper. This shifts the IS curve to the left.
How does a depreciation of the domestic currency affect net exports?
A depreciation of the domestic currency increases net exports by making domestic goods cheaper and foreign goods more expensive. This shifts the IS curve to the right.
Why is fiscal policy slower to implement than monetary policy?
Fiscal policy changes often require parliamentary approval and can involve lengthy processes, whereas central banks can intervene in financial markets more quickly.
How does an increase in government spending affect output in a closed economy?
In a closed economy, an increase in government spending leads to an increase in output and interest rates, with some crowding out of private investment.
How does an increase in government spending affect output in an open economy with fixed exchange rates?
In an open economy with fixed exchange rates, the increase in output is larger than in a closed economy because the central bank accommodates the increase in interest rates by increasing the money supply, which prevents crowding out of private investment.
How does an increase in government spending affect output in an open economy with flexible exchange rates?
In an open economy with flexible exchange rates, an increase in government spending is offset by a decrease in net exports, so the overall effect on output is zero.
