Post on 31-Dec-2015
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Session 22How Does the Open
Macro-economy Work?
National Macro-economic Performance Goals
Internal Balance
Full employment, or an acceptably low unemployment rate
Price stability, or an acceptably low inflation rate
External balance
Sustainable composition of the country’s balance of payments with the rest of the world
A Basic Framework for Macro-economic Analysis
Domestic production depends on aggregate demand.
GDP = C + I + G + (X – M)
Aggregate Expenditure = C + I + G + (X – M)
Aggregate Demand = C + I + G + (X – M)
Inflation =
Trade depends on income.
A More Complete Framework : Three MarketsMundell – Fleming Model
The Domestic Product Market
The Money Market
The Foreign Exchange Market (Balance of Payment)
The Investment – Saving Curve (Product Market)
Some Exogenous shocks that shift the IS curve up (or to the right)
IS2
up
An increase in government spending or a tax cut
An improved customer expectations about the future
The shift in the tastes of foreign customers toward the country’s products.
The Liquidity – Money Curve (Money Market)
Some Exogenous shocks that shift the LM curve down (or to the right)
LM2Down
An increase in government spending or a tax cut
A decrease in average price level ( i.e., due to a decline in oil prices)
The introduction of credit cards.
The Foreign Exchange Market (or Balance of Payment)
Some Exogenous shocks that shift the FE curve down (or to the right)
FE2
Down
An increase in exports
The country’s currency value decrease (i.e., from ฿ 25/ $ 1 to ฿ 50/ $ 1)
Inflow > Outflow(Export > Import)
A decrease in imports
Inflow < Outflow(Export < Import)
A decrease in foreign interest rate
A increase in the expected rate of appreciation of the country’s currency
฿ 25/ $ 1
More inflow dollars
Based on the expectation, the dollar holders could make the profit as follows
฿ 20/ $ 1 the expected rate of appreciation
$ 1 ฿ 25
Now ฿ 5 (profit)
฿ 20 = $1 (cost) $ 1
Future
As a result of the expected rate of appreciation, the following happens
More demand for baht
The value of baht will decrease (฿ 25/ $ 1 to ฿30/ $1)
Macro-economic Policies