1、20-120-2chapter20international adjustment and interdependence item item item etc.mcgraw-hill/irwinmacroeconomics, 10e 2008 the mcgraw-hill companies, inc., all rights reserved.20-3introductioncountries are interdependentbooms or recessions in one country spill over to other countries through trade f

2、lowschanges in interest rates in any major country cause immediate exchange or interest rate movements in other countriesin this chapter we explore the issues of international interdependence further:mechanisms through which a country with a fixed exchange rate adjusts to balance of payments problem

3、saspects of behavior of the current flexible exchange rate system20-4adjustment under fixed exchange ratesadjustment to a balance-of-payments problem can be achieved in two ways:change in economic policymonetary policyfiscal policytariffsdevaluations automatic adjustment mechanismsmoney supply spend

4、ingunemployment wages and prices competitiveness 20-5the role of prices in the open economythe real exchange rate is expressed as: (1) assume that exchange rate and foreign prices are givenhow does the openness of the economy affect the aggregate demand curve?an increase in the price level reduces d

5、emandhigher price level implies lower real balances, higher interest rates, and reduced spending given the exchange rate, our goods are more expensive to foreigners and their goods are relatively cheaper for us to buy exports decrease and imports increasepeprf20-6the role of prices in the open econo

6、myfigure 20-1 shows the downward sloping ad curve where and the nx = 0 curve at point e the home country has a trade deficitto achieve trade balance equilibrium, we would have tobecome more competitive (exporting more and importing less)reduce our level of income in order to reduce import spendingin

7、sert figure 20-1 herenxdsad20-7the role of prices in the open economywhat should the country do?the central bank could use its reserves to finance temporary imbalances of paymentscan borrow foreign currencies abroadmay be troublesome if the countrys ability to repay the debt is in questioncountry mu

8、st find a way of adjusting the deficitcannot maintain and finance current account deficits indefinitely or for long periods of timeinsert figure 20-1 here20-8the role of prices in the open economyautomatic adjustmentwhen the central bank sells foreign exchange, it reduces domestic high powered money

9、 and the money stockthe deficit at e implies the central bank is pegging the exchange rate, selling foreign exchange to keep the exchange rate from depreciatingover time the ad schedule, which is drawn for a given money supply, will be shifting downward and to the leftinsert figure 20-1 here20-9the

10、role of prices in the open economyautomatic adjustmentpoint e is also a point of unemploymentunemployment leads to declines in wages and costsover time, the sr equilibrium point, e, moves downward as the as and ad shiftprocess continues until reach point epoint e is a lr equilibrium point and there

11、is no need for exchange market equilibrium automatic adjustmentinsert figure 20-1 here20-10policies to restore balancethe classical adjustment process may take time alternative is policies to restore external balancebecause of their side effects, policies to restore external balance must generally b

12、e combined with policies to achieve full employmentpolicies to create employment will typically worsen the external balancepolicies to create a trade surplus will affect employmentnecessary to combine expenditure-switching policies, which shift demand between domestic and imported goods, and expendi

13、ture-reducing/increasing policies in order to cope with the two targets of internal balance and external balance.20-11policies to restore balancecan use policies to reduce aggregate demand expenditure reducing policiesthe trade deficit is expressed as (2)a balance-of-trade deficit can be reduced by

14、reducing spending (c+i+g) relative to income through restrictive monetary and/or fiscal policythe link between the external deficit and budget deficits is shown in equation (2a): (2a)if s and i are constant, changes in the budget would translate one for one into changes in the external balance budge

15、t cutting would bring about equal changes in the external deficit but budget cutting will affect s and i, thus need a more complete model to explain how budget cuts affect external balance )(gicynx)()(trgtaisnx20-12devaluationthe unemployment that accompanies automatic adjustment suggests the need f

16、or an alternative policy for restoring internal and external balancethe major policy instrument for dealing with payment deficits is devaluation = an increase in the domestic currency price of foreign exchangegiven the nominal prices in the two countries, devaluation:increases the relative price of

17、imported goods in the devaluing countryreduces the relative price of exports from the devaluing countrydevaluation is primarily an expenditure switching policy.20-13exchange rates and pricesthe price level typically changes with the exchange rate (including after a devaluation)the essential issue wh

18、en a country devalues is whether it can achieve a real devaluationa real devaluation occurs when it reduces the price of the countrys own goods relative to the price of foreign goodsusing the definition of the real exchange rate: a real devaluation occurs when e/p rises or when the exchange rate inc

19、reases by more than the price levelpeprf20-14the monetary approach to the balance of paymentsthere is a link between the money supply and the external balance the adjustment process must ultimately lead to the right money stock so that external payments will be in balancethe only way the adjustment

20、process can be suspended is through sterilization operationscentral banks frequently offset the impact of foreign exchange market intervention on the money supply through omoa deficit country that is selling foreign exchange and correspondingly reducing its money supply may offset this reduction by

21、open market purchases of bonds that restore the money supplypersistent deficits are possible cb actively maintaining the stock of money too high for external balance sterilizationsterilization20-15interest differentials and exchange rate expectationsin our model of exchange rate determination intern

22、ational capital mobility was assumedwhen capital markets are sufficiently integrated, we expect interest rates to be equated across countriesfigure 20-9 shows the u.s. federal funds rate and the money market rate in germanythese rates are not equalinsert figure 20-9 herehow do we square this fact wi

23、th our theory?20-16exchange rate expectationshave assumed that capital flows internationally in response to nominal interest differentialstheory is incomplete when exchange rates can and are expected to changemust extend our analysis to incorporate expectations of exchange rate changestotal return o

24、n foreign bonds measured in our currency is the interest rate on the foreign currency plus whatever earned from the appreciation of the foreign currency, or (5) eeif20-17exchange rate expectationsinvestor does not know at the time of investment how much the exchange rate will changethe term should be interpreted as the expected change in the exchange rateth