12 The Open Economy Revisited

Transcription

1 CHPTER 12 Th Opn Economy Rvisitd Qustions fo Rviw 1. In th Mundll Flming modl, an incas in taxs shifts th IS cuv to th lft. If th xchang at floats fly, thn th LM cuv is unaffctd. s shown in Figu 12 1, th xchang at falls whil agggat incom mains unchangd. Th fall in th xchang at causs th tad balanc to incas. LM Figu 12 1 Exchang at Incom, output 119

2 120 nsws to Txtbook Qustions and Poblms Now suppos th a fixd xchang ats. Whn th IS cuv shifts to th lft in Figu 12 2, th mony supply has to fall to kp th xchang at constant, shifting th LM cuv fom to. s shown in th figu, output falls whil th xchang at mains fixd. Nt xpots can only chang if th xchang at changs o th nt xpots schdul shifts. Nith occus h, so nt xpots do not chang. Figu 12 2 Exchang at Fixd xchang at 2 1 Incom, output IS IS 1 2 W conclud that in an opn conomy, fiscal policy is ffctiv at influncing output und fixd xchang ats but inffctiv und floating xchang ats. 2. In th Mundll Flming modl with floating xchang ats, a duction in th mony supply ducs al balancs M/P, causing th LM cuv to shift to th lft. s shown in Figu 12 3, this lads to a nw quilibium with low incom and a high xchang at. Th incas in th xchang at ducs th tad balanc. Figu 12 3 Exchang at IS 2 1 Incom, output

3 Chapt 12 gggat Dmand in th Opn Economy 121 If xchang ats a fixd, thn th upwad pssu on th xchang at focs th Fd to sll dollas and buy foign xchang. This incass th mony supply M and shifts th LM cuv back to th ight until it achs again, as shown in Figu Figu 12 4 Exchang at Fixd xchang at IS Incom, output In quilibium, incom, th xchang at, and th tad balanc a unchangd. W conclud that in an opn conomy, montay policy is ffctiv at influncing output und floating xchang ats but impossibl und fixd xchang ats. 3. In th Mundll Flming modl und floating xchang ats, moving a quota on impotd cas shifts th nt xpots schdul inwad, as shown in Figu s in th figu, fo any givn xchang at, such as, nt xpots fall. This is bcaus it now bcoms possibl fo micans to buy mo Toyotas, Volkswagns, and oth foign cas than thy could whn th was a quota. Figu 12 5 Exchang at NX 1 () NX 2 () NX 2 NX 1 Nt xpots NX

4 122 nsws to Txtbook Qustions and Poblms This inwad shift in th nt-xpots schdul causs th IS schdul to shift inwad as wll, as shown in Figu LM Figu 12 6 Exchang at 1 2 Incom, output Th xchang at falls whil incom mains unchangd. Th tad balanc is also unchangd. W know this sinc NX () = C( T) I() G. Rmoving th quota has no ffct on, C, I, o G, so it also has no ffct on th tad balanc. Th dclin in nt xpots causd by th moval of th quota is xactly offst by th incas in nt xpots causd by th dclin in th valu of th xchang at. If th a fixd xchang ats, thn th shift in th IS cuv puts downwad pssu on th xchang at, as abov. In od to kp th xchang at fixd, th Fd is focd to buy dollas and sll foign xchang. This shifts th LM cuv to th lft, as shown in Figu Figu 12 7 Exchang at 2 1 Incom, output In quilibium, incom is low and th xchang at is unchangd. Th tad balanc falls; w know this bcaus nt xpots a low at any lvl of th xchang at.

5 Chapt 12 gggat Dmand in th Opn Economy Th following tabl lists som of th advantags and disadvantags of floating vsus fixd xchang ats. Tabl 12 1 Floating Exchang Rats dvantags: Disadvantags: llows montay policy to pusu goals oth than just xchang-at stabilization, fo xampl, th stability of pics and mploymnt. Exchang-at unctainty is high, and this might mak intnational tad mo difficult. Fixd Exchang Rats dvantags: Disadvantags: Maks intnational tad asi by ducing xchang at unctainty. It disciplins th montay authoity, pvnting xcssiv gowth in M. s a montay ul, it is asy to implmnt. Montay policy cannot b usd to pusu policy goals oth than maintaining th xchang at. s a way to disciplin th montay authoity, it may lad to gat instability in incom and mploymnt. 5. Th impossibl tinity stats that it is impossibl fo a nation to hav f capital flows, a fixd xchang at, and indpndnt montay policy. In oth wods, you can only hav two of th th. If you want f capital flows and an indpndnt montay policy, thn you cannot also pg th xchang at. If you want a fixd xchang at and f capital flows, thn you cannot hav indpndnt montay policy. If you want to hav indpndnt montay policy and a fixd xchang at, thn you nd to stict capital flows. Poblms and pplications 1. Th following th quations dscib th Mundll Flming modl: = C( T) + I() + G + NX(). (IS) M/P = L(, ). (LM) =. In addition, w assum that th pic lvl is fixd in th shot un, both at hom and aboad. This mans that th nominal xchang at quals th al xchang at. a. If consums dcid to spnd lss and sav mo, thn th IS cuv shifts to th lft. Figu 12 8 shows th cas of floating xchang ats. Sinc th mony supply dos not adjust, th LM cuv dos not shift. Sinc th LM cuv is unchangd, output is also unchangd. Th xchang at falls (dpciats), which causs an incas in th tad balanc qual to th fall in consumption.

6 124 nsws to Txtbook Qustions and Poblms LM Figu 12 8 Exchang at Incom, output Figu 12 9 shows th cas of fixd xchang ats. Th IS cuv shifts to th lft, but th xchang at cannot fall. Instad, output falls. Sinc th xchang at dos not chang, w know that th tad balanc dos not chang ith. Figu 12 9 Exchang at 2 1 Incom, output IS 2 In ssnc, th fall in dsid spnding puts downwad pssu on th intst at and, hnc, on th xchang at. If th a fixd xchang ats, thn th cntal bank buys th domstic cuncy that invstos sk to xchang, and povids foign cuncy, shifting LM to th lft. s a sult, th xchang at dos not chang, so th tad balanc dos not chang. Hnc, th is nothing to offst th fall in consumption, and output falls.

7 Chapt 12 gggat Dmand in th Opn Economy 125 b. If som consums dcid thy pf stylish Toyotas to Fods and Chysls, thn th nt-xpots schdul, shown in Figu 12 10, shifts to th lft. That is, at any lvl of th xchang at, nt xpots a low than thy w bfo. Figu Exchang at NX 1 NX 2 Nt xpots NX This shifts th IS cuv to th lft as wll, as shown in Figu fo th cas of floating xchang ats. Sinc th LM cuv is fixd, output dos not chang, whil th xchang at falls (dpciats). LM Figu Exchang at 1 2 Incom, output Th tad balanc dos not chang ith, dspit th fall in th xchang at. W know this sinc NX = S I, and both saving and invstmnt main unchangd. Whn consums pf to buy foign cas, this will dcas nt xpots. Th sulting dclin in th valu of th xchang at will incas nt xpots and offst th dclin, such that nt xpots mains unchangd Figu shows th cas of fixd xchang ats. Th lftwad shift in th IS cuv puts downwad pssu on th xchang at. Th cntal bank buys dollas and slls foign xchang to kp fixd: this ducs M and shifts th LM cuv to th lft. s a sult, output falls.

8 126 nsws to Txtbook Qustions and Poblms Figu Exchang at 2 1 Incom, output Th tad balanc falls, bcaus th shift in th nt xpots schdul mans that nt xpots a low fo any givn lvl of th xchang at. c. Th intoduction of TM machins ducs th dmand fo mony. W know that quilibium in th mony makt quis that th supply of al balancs M/P must qual dmand: M/P = L(, ). fall in mony dmand mans that fo unchangd incom and intst ats, th ight-hand sid of this quation falls. Sinc M and P a both fixd, w know that th lft-hand sid of this quation cannot adjust to sto quilibium. W also know that th intst at is fixd at th lvl of th wold intst at. This mans that incom th only vaiabl that can adjust must is in od to incas th dmand fo mony. That is, th LM cuv shifts to th ight. Intuitivly, th dclin in mony dmand will put downwad pssu on th intst at. This will caus capital outflow until balanc is stod bcaus in this modl th intst at will main qual to th wold intst at. s capital flows out of th conomy, th xchang at will fall. This will incas nt xpots and output. Figu shows th cas with floating xchang ats. Incom iss, th xchang at falls (dpciats), and th tad balanc iss. Figu Exchang at 1 2 IS 1 2 Incom, output

9 Chapt 12 gggat Dmand in th Opn Economy 127 Figu shows th cas of fixd xchang ats. Th LM schdul shifts to th ight; as bfo, this tnds to push domstic intst ats down and caus th cuncy to dpciat. Howv, th cntal bank buys dollas and slls foign cuncy in od to kp th xchang at fom falling. This ducs th mony supply and shifts th LM schdul back to th lft. Th LM cuv continus to shift back until th oiginal quilibium is stod. LM Figu Exchang at IS 1 Incom, output In th nd, incom, th xchang at, and th tad balanc a unchangd. 2. Th conomy is in cssion, at point in Figu To incas incom, th cntal bank should incas th mony supply, thby shifting th LM cuv to th ight. If only that happnd, th conomy would mov to point, with a dpciatd xchang at that would stimulat xpots and ais th tad balanc. To kp th xchang at fom dpciating and th tad balanc fom ising, th fiscal authoitis should cut taxs o incas govnmnt spnding. That would shift th IS cuv to th ight, so that th conomy would mov to point C. Und th assumption in th chapt that nt xpots dpnd only on th xchang at, this would kp th tad Figu Exchang at 1 C Incom, output

10 128 nsws to Txtbook Qustions and Poblms balanc fom changing. Th incas in output and incom would, instad, flct an incas in domstic dmand. (Not that without th montay xpansion, a fiscal xpansion by itslf would lad to a high xchang at so th incas in domstic dmand would b offst by a duction in th tad balanc. 3. a. Th Mundll Flming modl taks th wold intst at as an xognous vaiabl. Howv, th is no ason to xpct th wold intst at to b constant. In th closd-conomy modl of Chapt 3, th quilibium of saving and invstmnt dtmins th al intst at. In an opn conomy in th long un, th wold al intst at is th at that quilibats wold saving and wold invstmnt dmand. nything that ducs wold saving o incass wold invstmnt dmand incass th wold intst at. In addition, in th shot un with fixd pics, anything that incass th woldwid dmand fo goods o ducs th woldwid supply of mony causs th wold intst at to is. b. Figu shows th ffct of an incas in th wold intst at und floating xchang ats. oth th IS and th LM cuvs shift. Th IS cuv shifts to th lft, bcaus th high intst at causs invstmnt I( ) to fall. Th LM cuv shifts to th ight bcaus th high intst at ducs mony dmand. Sinc th supply of al balancs M/P is fixd, th high intst at lads to an xcss supply of al balancs. To sto quilibium in th mony makt, incom must is; this incass th dmand fo mony until th is no long an xcss supply. Intuitivly, whn th wold intst at iss, capital outflow will incas as th intst at in th small county adjusts to th nw high lvl of th wold intst at. Th incas in capital outflow causs th xchang at to fall, causing nt xpots and hnc output to incas, which incass mony dmand. Figu Exchang at Incom, output W s fom th figu that output iss and th xchang at falls (dpciats). Hnc, th tad balanc incass.

11 Chapt 12 gggat Dmand in th Opn Economy 129 c. Figu shows th ffct of an incas in th wold intst at if xchang ats a fixd. oth th IS and LM cuvs shift. s in pat (b), th IS cuv shifts to th lft sinc th high intst at causs invstmnt dmand to fall. Th LM schdul, howv, shifts to th lft instad of to th ight. This is bcaus th downwad pssu on th xchang at causs th cntal bank to buy dollas and sll foign xchang. This ducs th supply of mony M and shifts th LM schdul to th lft. Th LM cuv must shift all th way back to in th figu, wh th fixd-xchang-at lin cosss th nw IS cuv. Figu Exchang at 2 1 Incom, output In quilibium, output falls whil th xchang at mains unchangd. Sinc th xchang at dos not chang, nith dos th tad balanc. 4. a. dpciation of th cuncy maks mican goods mo comptitiv. This is bcaus a dpciation mans that th sam pic in dollas tanslats into fw units of foign cuncy. That is, in tms of foign cuncy, mican goods bcom chap so that foigns buy mo of thm. Fo xampl, suppos th xchang at btwn yn and dollas falls fom 200 yn/dolla to 100 yn/dolla. If an mican can of tnnis balls costs $2.50, its pic in yn falls fom 500 yn to 250 yn. This fall in pic incass th quantity of mican-mad tnnis balls dmandd in Japan. That is, mican tnnis balls a mo comptitiv.

12 130 nsws to Txtbook Qustions and Poblms b. Consid fist th cas of floating xchang ats. W know that th position of th LM cuv dtmins output. Hnc, w know that w want to kp th mony supply fixd. s shown in Figu 12 18, w want to us fiscal policy to shift th IS cuv to th lft to caus th xchang at to fall (dpciat). W can do this by ducing govnmnt spnding o incasing taxs. Figu Floating xchang at. Fixd xchang ats LM LM Exchang at 1 2 Exchang at 1 2 C IS 1 1 Incom, output Incom, output Now suppos that th xchang at is fixd at som lvl. If w want to incas comptitivnss, w nd to duc th xchang at; that is, w nd to fix it at a low lvl. Th fist stp is to dvalu th dolla, fixing th xchang at at th dsid low lvl. This incass nt xpots and tnds to incas output, as shown in Figu W can offst this is in output with contactionay fiscal policy that shifts th IS cuv to th lft, as shown in th figu.

13 Chapt 12 gggat Dmand in th Opn Economy In th txt, w assumd that nt xpots dpnd only on th xchang at. This is analogous to th usual stoy in micoconomics in which th dmand fo any good (in this cas, nt xpots) dpnds on th pic of that good. Th pic of nt xpots is th xchang at. Howv, w also xpct that th dmand fo any good dpnds on incom, and this may b tu h as wll: as incom iss, w want to buy mo of all goods, both domstic and impotd. Hnc, as incom iss, impots incas, so nt xpots fall. Thus, w can wit nt xpots as a function of both th xchang at and incom: NX = NX(, ). Figu shows th nt xpots schdul as a function of th xchang at. s bfo, th nt xpots schdul is downwad sloping, so an incas in th xchang at ducs nt xpots. W hav dawn this schdul fo a givn lvl of incom. If incom incass fom 1 to 2, th nt xpots schdul shifts inwad fom NX( 1 ) to NX( 2 ). Figu Exchang at NX ( 1 ) NX ( 2 ) Nt xpots NX a. Figu shows th ffct of a fiscal xpansion und floating xchang ats. Th fiscal xpansion (an incas in govnmnt xpnditu o a cut in taxs) shifts th IS schdul to th ight. ut with floating xchang ats, if th LM cuv dos not chang, nith dos incom. Sinc incom dos not chang, th nt-xpots schdul mains at its oiginal lvl NX( 1 ). LM Figu Exchang at 1 Incom, 1 output Incom, output

14 132 nsws to Txtbook Qustions and Poblms Th final sult is that incom dos not chang, and th xchang at appciats fom 1 to 2. Nt xpots fall bcaus of th appciation of th cuncy. Thus, ou answ is th sam as that givn in Tabl b. Figu shows th ffct of a fiscal xpansion und fixd xchang ats. Th fiscal xpansion shifts th IS cuv to th ight, fom to. s in pat (a), fo unchangd al balancs, this tnds to push th xchang at up. To pvnt this appciation, howv, th cntal bank intvns in cuncy makts, slling dollas and buying foign xchang. This incass th mony supply and shifts th LM cuv to th ight, fom to. Figu Exchang at 1 2 Incom, output Output iss whil th xchang at mains fixd. Dspit th unchangd xchang at, th high lvl of incom ducs nt xpots bcaus th ntxpots schdul shifts inwad. Thus, ou answ diffs fom th answ in Tabl 12 1 only in that und fixd xchang ats, a fiscal xpansion ducs th tad balanc. 6. W want to consid th ffcts of a tax cut whn th LM cuv dpnds on disposabl incom instad of incom: M/P = L[, T].

15 Chapt 12 gggat Dmand in th Opn Economy 133 tax cut now shifts both th IS and th LM cuvs. Figu shows th cas of floating xchang ats. Th IS cuv shifts to th ight, fom to. Th LM cuv shifts to th lft, howv, fom to. 2 LM 2 LM 1 Figu Exchang at Incom, output W know that al balancs M/P a fixd in th shot un, whil th intst at is fixd at th lvl of th wold intst at. Disposabl incom is th only vaiabl that can adjust to bing th mony makt into quilibium: hnc, th LM quation dtmins th lvl of disposabl incom. If taxs T fall, thn incom must also fall to kp disposabl incom fixd. In Figu 12 22, w mov fom an oiginal quilibium at point to a nw quilibium at point. Incom falls by th amount of th tax cut, and th xchang at appciats. If th a fixd xchang ats, th IS cuv still shifts to th ight; but th initial shift in th LM cuv no long matts. That is, th upwad pssu on th xchang at causs th cntal bank to sll dollas and buy foign xchang; this incass th mony supply and shifts th LM cuv to th ight, as shown in Figu Figu Exchang at 1 2 Incom, output

16 134 nsws to Txtbook Qustions and Poblms Th nw quilibium, at point, is at th intsction of th nw IS cuv,, and th hoizontal lin at th lvl of th fixd xchang at. Th is no diffnc btwn this cas and th standad cas wh mony dmand dpnds on incom. 7. Sinc popl dmand mony balancs in od to buy goods and svics, it maks sns to think that th pic lvl that is lvant is th pic lvl of th goods and svics thy buy. This includs both domstic and foign goods. ut th dolla pic of foign goods dpnds on th xchang at. Fo xampl, if th dolla iss fom 100 yn/dolla to 150 yn/dolla, thn a Japans good that costs 300 yn falls in pic fom $3 to $2. Hnc, w can wit th condition fo quilibium in th mony makt as M/P = L(, ), wh P = λp d + (1 λ)p f /. a. high xchang at maks foign goods chap. To th xtnt that popl consum foign goods (a faction 1 λ), this lows th pic lvl P that is lvant fo th mony makt. This low pic lvl incass th supply of al balancs M/P. To kp th mony makt in quilibium, w qui incom to is to incas mony dmand as wll. Hnc, th LM cuv is upwad sloping. b. In th standad Mundll Flming modl, xpansionay fiscal policy has no ffct on output und floating xchang ats. s shown in Figu 12 24, this is no long tu h. cut in taxs o an incas in govnmnt spnding shifts th IS cuv to th ight, fom to. Sinc th LM cuv is upwad sloping, th sult is an incas in output. LM Figu Exchang at Incom, output

17 Chapt 12 gggat Dmand in th Opn Economy 135 c. Th incas in th isk pmium aiss th intst at fo this county, lowing mony dmand at any givn xchang at and thby shifting th LM cuv to th ight. Intuitivly, if al-mony balancs a fixd, thn al-mony dmand must main fixd. Th dclin in mony dmand causd by th incas in th intst at must b offst by an incas in mony dmand causd by an incas in incom. Th duction in mony dmand causd by th incas in th intst at lads to a high lvl of incom fo any givn mony supply. Th high intst at also ducs invstmnt spnding at any givn xchang at, shifting th IS cuv to th lft. s shown in Figu 12-25, th xchang at falls and output may ith is o fall dpnding on th siz of th shifts. LM Figu Exchang at 1 1 Incom, output If mony dmand is not vy snsitiv to th intst at and invstmnt is vy snsitiv to th intst at, thn IS will shift by mo than LM and output will dclin. Compad to th taditional Mundll-Flming modl, wh LM is vtical, output can fall h, whas it dos not fall in th taditional modl but instad always iss. This modl givs th mo alistic sult that both th xchang at and output a likly to dclin whn th isk pmium iss. 8. a. Califonia is a small opn conomy, and w assum that it can pint dolla bills. Its xchang at, howv, is fixd with th st of th Unitd Stats: on dolla can b xchangd fo on dolla. b. In th Mundll Flming modl with fixd xchang ats, Califonia cannot us montay policy to affct output, bcaus this policy is alady usd to contol th xchang at. Hnc, if Califonia wishs to stimulat mploymnt, it should us fiscal policy. c. In th shot un, th impot pohibition shifts th IS cuv out. This incass dmand fo Califonian goods and puts upwad pssu on th xchang at. To countact this, th Califonian mony supply incass, so th LM cuv shifts out as wll. Th nw shot-un quilibium is at point K in Figus 12 26() and (). ssuming that w statd with th conomy poducing at its natual at, th incas in dmand fo Califonian goods tnds to ais thi pics. This is in th pic lvl lows al mony balancs, shifting th shot-un S cuv upwad and th LM cuv inwad. Evntually, th Califonian conomy nds up at point C, with no chang in output o th tad balanc, but with a high al xchang at lativ to Washington.

18 136 nsws to Txtbook Qustions and Poblms. Th Mundll-Flming Modl LM Figu C Exchang at K IS Incom, output. Th Modl of gggat Supply and gggat Dmand P P 2 C Pic lvl P 1 K SRS D 2 Incom, output D 1

19 Chapt 12 gggat Dmand in th Opn Economy 137 Mo Poblms and pplications to Chapt a. High taxs shift th IS cuv inwad. To kp output unchangd, th cntal bank must incas th mony supply, shifting th LM cuv to th ight. t th nw quilibium (point C in Figu 12 27), th intst at is low, th xchang at has dpciatd, and th tad balanc has isn. Figu Th IS LM Modl. Nt Capital Outflow Ral intst at 1 C 2 () Incom, output Nt capital outflow C. Th Makt fo Foign Exchang Exchang at 1 2 NX() NX 1 Nt xpots NX 2

20 138 nsws to Txtbook Qustions and Poblms b. Rsticting th impot of foign cas shifts th NX() schdul outwad [s panl (C)]. This has no ffct on ith th IS cuv o th LM cuv, howv, bcaus th schdul is unaffctd. Hnc, output dosn t chang and th is no nd fo any chang in montay policy. s shown in Figu 12 28, intst ats and th tad balanc don t chang, but th xchang at appciats. Figu Th IS-LM Modl. Nt Capital Outflow LM Ral intst at IS () Incom, output Nt capital outflow C. Th Makt fo Foign Exchang Exchang at 2 1 NX() 2 NX() 1 Nt xpots NX

21 Chapt 12 gggat Dmand in th Opn Economy a. Th cuv bcoms flatt, bcaus a small chang in th intst at now has a lag ffct on capital flows. b. s agud in th txt, a flatt cuv maks th IS cuv flatt, as wll. c. Figu shows th ffct of a shift in th LM cuv fo both a stp and a flat IS cuv. It is cla that th flatt th IS cuv is, th lss ffct any chang in th mony supply has on intst ats. Hnc, th Fd has lss contol ov th intst at whn invstos a mo willing to substitut foign and domstic assts. d. It is cla fom Figu that th flatt th IS cuv is, th gat ffct any chang in th mony supply has on output. Hnc, th Fd has mo contol ov output. Figu Ral intst at C flat C stp IS flat IS stp Incom, output

22 140 nsws to Txtbook Qustions and Poblms Figu a. No. It is impossibl to ais invstmnt without affcting incom o th xchang at just by using montay and fiscal policis. Invstmnt can only b incasd though a low intst at. Rgadlss of what policy is usd to low th intst at (.g., xpansionay montay policy and contactionay fiscal policy), nt foign invstmnt will incas, lowing th xchang at. b. s. Policymaks can ais invstmnt without affcting incom o th xchang at with a combination of xpansionay montay policy and contactionay fiscal policy, and potction against impots can ais invstmnt without affcting th oth vaiabls. oth th montay xpansion and th fiscal contaction would put downwad pssu on intst ats and stimulat invstmnt. It is ncssay to combin ths two policis so that thi ffcts on incom xactly offst ach oth. Th low intst ats will, as in pat (a), incas nt capital outflow, which will put downwad pssu on th xchang at. Th potctionist policis, howv, shift th nt-xpots cuv out; this puts countvailing upwad pssu on th xchang at and offsts th ffct of th fall in intst ats. Figu shows this combination of policis. 1 2 () 1, Incom, output Nt capital outflow 1 2 1, 2 NX() Nt xpots NX

23 Chapt 12 gggat Dmand in th Opn Economy 141 Figu c. s. Policymaks can ais invstmnt without affcting incom o th xchang at though a hom montay xpansion and fiscal contaction, combind with a low foign intst at ith though a foign montay xpansion o fiscal contaction. Th domstic policy lows th intst at, stimulating invstmnt. Th foign policy shifts th cuv inwad. Evn with low intst ats, th quantity of capital outflow would b unchangd and th would b no pssu on th xchang at. This combination of policis is shown in Figu () 1, 2 1, 2 Incom, output Nt capital outflow 1 1, 2 NX() NX 1 NX 2 NX Nt xpots 4. a. Figu shows th ffct of a fiscal contaction on a lag opn conomy with a fixd xchang at. Th fiscal contaction shifts th IS cuv to th lft in panl

24 142 nsws to Txtbook Qustions and Poblms (), which puts downwad pssu on th intst at. This tnds to incas nt capital outflow and caus th xchang at to dpciat [s panls () and (C)]. To avoid this, th cntal bank intvns and buys dollas. This kps th xchang at fom dpciating; it also shifts th LM cuv to th lft. Th nw quilibium, at point C, has an unchangd intst at and xchang at, but low output. This ffct is th sam as in a small opn conomy. Figu Th IS-LM Modl. Nt Capital Ouflow Ral intst at C Incom, output Nt capital outflow C. Th Makt fo Foign Exchang Exchang at NX() Nt xpots NX

25 Chapt 12 gggat Dmand in th Opn Economy 143 b. montay xpansion tnds to shift th LM cuv to th ight, lowing th intst at [panl () in Figu 12 33]. This tnds to incas nt capital outflow and caus th xchang at to dpciat [s panls () and (C)]. To avoid this dpciation, th cntal bank must buy its cuncy and sll foign xchang. This ducs th mony supply and shifts th LM cuv back to its oiginal position. s in th modl of a small opn conomy, montay policy is inffctual und a fixd xchang at. Figu Th IS-LM Modl. Nt Capital Outflow Ral intst at IS () Incom, output Nt capital outflow C. Th Makt fo Foign Exchang Exchang at NX() Nt xpots NX