Week 10 Exchange rate policy Flashcards
What is a sudden stop?
Before 2008 countries in Europe were enjoying negative current account and having flow of capital from other countries.
This caused a very large unemployment.
What is a real exchange rate depreciation in terms of another variable?
Real exchange rate depreciation is an increase in e
What happened to the Eurozone countries during the sudden stop?
What was particularly strange that happened to Eurozone
-CA was deficits but then started getting less negative
-wages were increasing after 2008
-Unemplyoment was increasing after 2008
-These eurozxone countries did not have a real exchange rate depreciation.
As they were part of a monetary union
How do you show wage rigidities?
wt is greater than or equaled to lamda wt-1
With nominal rigidities lamda is close to 1
What empirical data shows evidence for nominal wage rigidities.
In great depression unemplyoment rose by 31%
but wages only fell by 0.6% in same time period
What is a historical example that being in a monetary union is bad?
When 1929 depression hit some countries like UK left Gold Standard
As a result,
What is the set up of that pins down exchange rate and unemployment
Two periods
two goods traded and non traded
PT = domestic price of traded goods
PN = domestic price of non-traded goods
P*T = foreign price of traded goods
St = nominal exchange rate
pt = PN/PT
Law of one price PT = PT . ST
Let PT =1
B*1 which are denominated in
What is a case study of a country that shows the impact of having a fixed exchange rate with a sudden stop
Argentina 1996-2006
After 1996 they had sharp increase in unemplyoment
-Nominal wages rose
-Real wage rose
In 2002 they stopped pegging their currency to the dollar and devalued it.
This then causes a large drop in unemployment
And a drop in the real wage
What do fixed exchange rate and nominal wage rigidities imply in tandem?
That real wages are not able to move.
What is the relative price of non-tradeables in the two period model?
pt = PN/ PT
What is the real exchange rate in the two period model and why is this?
Equaled to the relative price of non traded good PN / PT
What does relative price mean in the two period model?
-It is the price of non-traded goods w.r.t traded goods
What is the problem of the households in the traded and non traded goods two period model?
what is the framework?
C1T = consumption period 1 of traded goods
C1N = consumption period 1 of non traded goods
C2T = consumption period 2 of traded goods
C2N = consumption period 2 of non traded goods
Yt = income in terms of tradable.
r1 interest rate on assets
Households want to max
U(C1T, C1N) + U(C2T, C2N) S.T BC
What are the one period budget constraint in the model with traded and non traded goods
How do we get the IBC?
P1T . C1T + P1N .C1N + PT . B1 = PT . Y1 + (1+r0)B0
P2T . C2T + P2N . C2N + PT . B2 = PT . Y2 + (1+r1) . B1
We divide everything by PT
B*2 = 0
IBC
c1T +p1C1N + C2T + P2C2N / 1+r1 = Y1 + Y2 / 1+r1
What is a first order condition given by the traded and non-traded good model?
What can this be interpreted as?
U1(C1N, C1T) / U2(C2N, C2T) = p1
MRS between tradable and non-tradable = relative price / rer (NT w.r.t tradable
This is because p1 is relative price of non traded so if this increases they switch between non traded to traded.
Can be interpreted as the demand function of non-tradables as a function of the RER.
What type of slope does the demand F.O.C have with the household with traded and non-traded and why is this?
What is a caveat for this?
Negative slope
As if relative price of Nt increases it means that PNT increases which means they will consume less PNT
Needs to be a normal good
What is the demand F.O.C with a log function and what does this show
p1 = 1-a/a (CT1/CN1)
CN is a negative function of p1
What is the impact of an interest rate increase that causes a sudden stop?
higher r causes C1T to decrease
What is the production side of the economy with traded and non-traded goods?
QTN = F(ht) where ht is hours of labour.
Where F is an increasing and concave function.
Nominal profits of firms are
PNT . QTN - Wt . ht
Wt is the nominal wage
Divide by PT
pt . F(ht) - (Wt/St)ht
What is the demand for labour first order condition?
pt = (wt/st) / Fâ(ht)
Demand for labour in non-traded sector
How can you show the supply of non-traded goods?
Why is the relationship like this?
h on x axis
p on y axis
upward sloping line.
higher prices increase the value of marginal product.
What is the behaviour of the supply of non-traded goods and what does this tell us?
- As pt = Wt/St / Fâ(ht)
as nominal rigities are present Wt > equaled to gamma Wt-1
As they belong to monetary union nominal exchange rate is fixed.
Therefore, demand for non-traded goods fall, this means the value of MP decreases and thus the schedule can only shift up.
What is the condition of demand in nontraded good markets?
As they cannot be exported the demand of non traded goods must be equaled to supply when market clears.
cNT = QNT = F(ht)
What is the supply of hours worked in the nont traded goods model?
What impact does this have on the model?
Workers supply h bar hours inelastically, but may not be able to sell them all as firms are constrained.
ht is less than or equaled to h bar
- it means there is unemployment .
