Class Notes (811,316)
MGEA06H3 (157)
Iris Au (146)
Lecture

# Lecture notes for week 12

5 Pages
192 Views

School
University of Toronto Scarborough
Department
Economics for Management Studies
Course
MGEA06H3
Professor
Iris Au
Semester
Winter

Description
OPEN ECONOMY (PART 2) Outline N A brief review of what we have learned for an open economy. N Discuss the effectiveness of monetary and fiscal policies under flexible exchange rate. N Discuss the effectiveness of monetary and fiscal policies under fixed exchange rate. N Wrap up the course! Open EconomyA Brief Review The AE Model in Generic Formthe Full Version Consumption: C = C 0 c 1I, where DI = Y T + TR Investment: I = 0 d (r 1 ) where r1is a constant Government sector: G T = T0+ tr1Y TR = TR 0 tr1Y Foreign sector: X = X 0 x (1 E ),1where E is1a constant IM = IM 0 + im 1 + im (2 E ),1where E is1a constant N The AE function: AE = C + I + G + X IM AE = C 0+ c 1Y (T +0tr Y1 + (TR 0r Y)1 + [I 0 (r r )1 + G + [X 0 (E1 E )] 1 [IM + im0Y + i1 (E E2)] 1 AE = C + I + G + X IM c T + c TR d (r r ) (x + im ) (E E ) + [c (1 t tr ) im ] Y 0 0 0 0 1 0 1 0 1 1 2 1 1 1 1 1 AE = AE + 0 Y,Y where AE 0= C 0 I 0 G + X 0M c 0 + 1 0R 1 0 d (r 1 ) 1x + i2 ) (E 1 ) c = c (1 t tr ) im Y 1 1 1 1 where r1 and E1is a constant *** These two terms show how a change in interest rates and exchange rates change the AE function and equilibrium level of output. N Equilibrium level of output (equating Y = AE): Observations N Holding all else constant, a change in E would affect both exports and imports, which then affects AE (via a change in AE ) a0d Y. o When C\$ appreciates (E increases), Canadian goods become more expensive X decreases and IM increases AE decreases Y decreases. N A change in interest rate has two affects on the economy: 1) It affects the cost of borrowing and then investment. When r increases, cost of borrowing increases I decreases Y decreases. 2) It also has a significant impact on the exchange rate due to capital movements. When r increases, Canadian assets become more attractive foreigners buy more Canadian assets capital inflows. Demand for C\$ increases C\$ appreciates (E increases). N A change in interest rate will cause the exchange rate to change; therefore, a change in interest rate has a large effect on X and IM. o r increases C\$ appreciates (E increases) X decreases and IM increases AE decreases Y decreases. Effectiveness of Monetary and Fiscal Policies under Flexible Exchange Rate Case 1: Monetary Policy under Flexible Exchange Rate The central bank runs expansionary monetary policy: N Suppose the central bank buys bonds, MS increases. N At r , people find that they havetoo much liquidity (excess supply of money), and they will try to get rid of the excess liquidity by buying bonds. N bond prices increase and interest rate decreases (r decreases) N r decreases cost of borrowing decreases I increases AE increases Y increases N The SMALL modification: N Y increases L (r, Y) increases by a small amount www.notesolution.com
More Less

Related notes for MGEA06H3

OR

Don't have an account?

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Join to view

OR

By registering, I agree to the Terms and Privacy Policies
Just a few more details

So we can recommend you notes for your school.