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Lecture 12

MGEB06H3 Lecture 12: Macroeconomics NotesL12P2


Department
Economics for Management Studies
Course Code
MGEB06H3
Professor
Iris Au
Lecture
12

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Macroeconomics Notes: Lecture Twelve (Chapter Nineteen Part FOUR):
Expansionary monetary policy taken a change in E into consideration
The central bank lowers the interest rate by 0.5 percentage point (i = 0.015), which also causes
DC to depreciate to 0.75:
Logic: When both i & E change, there will be changes in IPlanned, X & IM.
Cost of borrowing IPlanned :
IPlanned = ( d ×i) = [ 5000 × ( 0.005)] = 25
DC depreciates domestic goods become less expensive X :
X = ( X1 EFC/DC) = [ 15 × ( 0.25)] = 3.75
DC depreciates domestic goods become less expensive IM :
IM = IM2 EFC/DC = [25 × ( 0.25)] = 6.25
Overall, AE0 = IPlanned + X IM = 25 + 3.75 ( 6.25) = 35
New AEPlanned function:
AEPlanned = (
+ AE0) + [MPC×(1 t tr) IM1]×Y
AEPlanned = [1900 + 35] + 0.5Y = 1935 + 0.5Y
Monetary Policy under Fixed Exchange Rate
Monetary policy is ineffective under fixed exchange rate, i.e., changes in monetary policy
will NOT change output.
Example: Expansionary monetary policy under fixed exchange rate
Suppose the central bank runs expansionary monetary policy, MS :
MS interest rate .
Cost of borrowing IPlanned .
Today’s consumption become less expensive C .
AEPlanned & AD Y .
In an open economy, when interest rate , domestic assets become less attractive:
Exports of assets capital inflows DDC .
Imports of assets capital outflows SDC .
DC depreciates (and deviates from the official exchange rate).
Fiscal Policy Under Flexible Exchange Rate
Fiscal policy is less effective under flexible exchange rate, i.e., changes in fiscal policy will
only lead to a small change in output in the short run.
Expansionary fiscal policy a change i & E (Weeks 11 & 12)
The government increases its spending by 50, which also causes the interest rate to rise by 0.5
percentage point and DC to appreciate to 1.2.
Logic: When these change, there will be changes in G, IPlanned, X and IM.
Government spending G = 50
Cost of borrowing IPlanned :
IPlanned = ( d ×i) = [ 5000 × 0.005] = 25
DC appreciates domestic goods become more expensive X :
X = ( X1 EFC/DC) = [ 15 × 0.2] = 3
DC appreciates domestic goods become more expensive IM
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