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lecture 29 ~ chapter 15.docx
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Department
Economics
Course
ECON 1BB3
Professor
Hannah Holmes
Semester
Fall

Description
What can the government of a small open economy do about business cycles?   government can only use one policy  fiscal policy or monetary policy depending on exchange rate “regime” (fixed exchange rates or flexible exchange rates) o flexible exchange rates:  nominal exchange rate – “e” is determined by market forces (supply & demand)  if pple buy foreign currency (selling Canadian dollars)  “e” to go down, which makes Real Exchancge Rate go down  if pple are buying Canadian dollars  “e” goes up, RER goes up o fixed exchange rates:  central bank  buy or sell canadiam dollars to keep the exchange rate fixed  goal is to shift AD to prevent recession… Expansionary Monetary policy. Flexible exchange rates  expansionary monetary policy = increase in the Ms  AD shift out  increase investment  decrease interest rate  Ms out to the right  Income increases  more money Md increases  Y increases (closed economy right now) increase in income from AD both curves shifting out to the right  (contractionary same set of steps but opposite direction)  r3 < rw  everyone prefers to buy foreign assets => pple need to buy foeign currency with Canadian dollars  everyones trying to sell their Canadian dollars values goes down, RER goes down  net exports increase, AD increase, Y increase, Md increases  this happens until r3 doesn’t exitst and we get to this point - small open economy with flexible exchange rates can use monetary policy in order to shift the AD curve Expansionary Fiscal policy, flexible exchange rates  Governement sepnding increases, AD increases, income increases, Md increases (we buy more stuff) Closed economy  R2 > rw  Want to buy Canadian assets  Pple buy Canadian dollars  RER increases, g/s more expensive than foreign g/s, import more of their goods, export less (NX decrease)  AD decreases, Income goes down, Md decreases  Complete crowding out Open economy – stays the same expansionary monetary policy, fixed exchange rates  Ms increasing, AD increase, income increase (y), Md inc
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