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Goods Market and Exchange Rate Dynamics

The document discusses exchange rate determination and the open economy goods and financial markets. It introduces the goods market model which shows GDP (Y) as the sum of consumption (C), investment (I), government spending (G) and net exports (X - eQ). It also discusses the J-curve effect where net exports may initially increase after a currency depreciation. The exchange rate is determined by international capital markets where the interest rate must equal the domestic rate plus the expected change in the exchange rate. The open economy IS-LM model shows the goods market equilibrium and money market equilibrium, with the exchange rate determined where the two curves intersect.

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manojverma231988
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61 views8 pages

Goods Market and Exchange Rate Dynamics

The document discusses exchange rate determination and the open economy goods and financial markets. It introduces the goods market model which shows GDP (Y) as the sum of consumption (C), investment (I), government spending (G) and net exports (X - eQ). It also discusses the J-curve effect where net exports may initially increase after a currency depreciation. The exchange rate is determined by international capital markets where the interest rate must equal the domestic rate plus the expected change in the exchange rate. The open economy IS-LM model shows the goods market equilibrium and money market equilibrium, with the exchange rate determined where the two curves intersect.

Uploaded by

manojverma231988
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Lecture 10: The Goods Market

and the Exchange Rate

Devaluations (static and dynamic responses) Exchange rate determination (capital markets) The open economy IS-LM

The Goods Market

Z = C + I + G + X - eQ C(Y-T) + I(Y,I) + G Q = Q(Y,e) +X = X(Y*,e) + +

Figures

Figs 19-4, 19-5


Increase in foreign demand
games countries play depreciation

The J-Curve

eQ(Y,e) : increase or decrease with e?


In the very short run: it may increase!
And if strong enough: X(Y*,e) - eQ(Y,e) may do the same. Dynamics of NX in response to a depreciation; fig 19-6

The Exchange Rate

The Goods Market Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E P*/P) constant Financial Markets M/P = YL(i) e i(t) = i*(t) + E(t+1) - E(t) E(t)

Cont. The Exchange Rate

i i*

e E

e i = i* + E - E E given E e and i*

The Open Economy IS-LM

Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*,E) M = Y L(i)


P
e E = E
1+i-i* e IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*))

Interest parity i LM

IS E

Two IS caveats:

a) Multiplier is smaller b) Interest rate affects aggregate demand through the E as well. * Fiscal and Monetary policy

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