EC4100: Macroeconomic Policies in the Short Run Philip R. Lane, TCD February 2010 Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 1 / 15
Introduction Integrated model of short-run macroeconomic uctuations: trade balance; exchange rate output; Textbook version: many compromises but easy to apply ( back of the envelope ) IMF, ECB, FED: more elaborate models but many similar predictions Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 2 / 15
Applications Analysis of shocks Analysis of monetary and scal policies Alternative exchange rate regimes Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 3 / 15
IS-LM-FX Model Version of Mundell-Fleming classic model Price stickiness: P, P and π e = 0. Ȳ xed, ī xed G, T policy choices NFIA = NUT = 0 =) Y = Q (GNDI = GDP) and TB = CA Level of demand determines output Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 4 / 15
Demand Components C = C (Y T ) [MPC] I = I (i) G = Ḡ [Fiscal balance: T Ḡ] TB = EX IM = TB(E P / P, Y T, Y T ) Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 5 / 15
The Trade Balance TB = TB(E P / P, Y T, Y T ) Expenditure Switching Relative Income Levels MPC = MPC H + MPC F Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 6 / 15
Figure 18.1 The Consumption Function
Figure 18.2 The Investment Function
Figure 18.3 The Trade Balance and the Real Exchange Rate
Marshall-Lerner Condition I Does real depreciation improve value of trade balance? Let initial position be TB = 0 =) EX = qim v TB measured in units of the home good EX = EXv [exports in same units as GDP with relative price of 1] IM = q IMv = q EX In general, TB = EX v qim v Response of TB wrt q TB q = EX v q q IM v q IM v Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 7 / 15
Marshall-Lerner Condition II In neighbourhood of TB = 0, can re-write as η EX = EX v q ML condition q EX v TB q TB q TB q q EX = η EX η IM 1 > 0; η IM = IM v q q IM v < 0 > 0 i η EX η IM > 1 > 0 i η EX + abs(η IM ) > 1 Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 8 / 15
J Curve Initially, nominal depreciation may reduce value of TB (J Curve dynamics) Nominal depreciation may not fully alter relative price of imports in short run export and import prices xed on world markets export and import prices both sticky in domestic currency market share concerns for importers large nontraded component in retail import prices Trade volumes respond slowly to real depreciation Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 9 / 15
Figure 18.4 The Real Exchange Rate and the Trade Balance: United States, 1975-2006
Table 18.1 Trade Dollarization
Figure 18.5 The J Curve
Goods Market Equilibrium Y = D = C (Y T ) + I (i) + Ḡ + TB(q, Y T, Y T ) Driving forces: Shocks to C (), I (), TB() Shocks to i, Ḡ, T,q (Sticky prices q driven by E) Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 10 / 15
Figure 18.6 Exogenous Shocks to Consumption, Investment, and the Trade Balance
Figure 18.6 Exogenous Shocks to Consumption, Investment, and the Trade Balance
Figure 18.6 Exogenous Shocks to Consumption, Investment, and the Trade Balance
Figure 18.7 The Goods Market Equilibrium and the Keynesian Cross
Figure 18.7 Shifts in Demand
Open-Economy IS curve Equilibrium in both goods market and FX market (i, Y ) space i operates through FX market in addition to I (i). IS = IS(G, T, i, E e, P, P,.) Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 11 / 15
Figure 18.8 Deriving the IS Curve
Figure 18.9 Exogenous Shifts in Demand Cause the IS Curve to Shift
LM curve Equilibrium in domestic money market (i, Y ) space i operates through FX market in addition to I (i). LM = LM(M/ P,.) Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 12 / 15
Figure 18.10 Deriving the LM Curve
Figure 18.11 Change in the Money Supply Shifts the LM Curve
Policy Analysis in IS-LM-FX Model Short-run impact of policies temporary policies (E e xed) Monetary-Float Monetary-Fix Fiscal-Float Fiscal-Fix Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 13 / 15
Figure 18.12 Equilibrium in the IS-LM-FX Model
Figure 18.13 Monetary Policy under Floating Exchange Rates
Figure 18.14 Monetary Policy under Fixed Exchange Rates
Figure 18.15 Fiscal Policy under Floating Exchange Rates
Figure 18.16 Fiscal Policy under Fixed Exchange Rates
Figure 18.17 U.S. Monetary and Fiscal Policy Shocks circa 1980
Figure 18.18 U.S. Monetary and Fiscal Policy, 1975 1990
Stabilisation Policies Policy responses to shocks Timing issues Most e ective in case of persistent, large shocks Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 14 / 15
Figure 18.19 Stabilization Policy under Floating Exchange Rates
Figure 18.20 Demand Shocks Down Under
Policy Constraints Exchange rate regime Fiscal space : funding risk Foreign-currency debt Incomplete information and the inside lag Outside lag Long-horizon plans J curve Pegged currency blocs Philip R. Lane, TCD () EC4100: Macroeconomic Policies in the Short Run February 2010 15 / 15