Equilibrium income and monetary policy strategy: teaching macroeconomics with the MP curve

Transcription

1 MPRA Munch Prsonal RPEc Archv Equlbrum ncom and montary polcy stratgy: tachng macroconomcs wth th MP curv Rosara Rta Canal Dpartmnto d Stud Economc, Unvrstà d Napol Parthnop 18. Dcmbr 2008 Onln at MPRA Papr No , postd 18. Dcmbr :00 UTC

2 EQUILIBRIUM INCOME AND MONETARY POLICY STRATEGY: TEACHING MACROECONOMICS WITH THE MP CURVE Rosara Rta Canal Abstract Th am of th papr s to prsnt a drvaton of a smpl tool dscrbng montary polcy bhavour, usful to tach macroconomc polcs n opn conoms, th MP curv. Th objctv s to ovrcom th lmts of th standard IS- LM modl and undrln th mportanc of th cntral bank stratgy n nfluncng output and mploymnt. W dmonstrat that f th man polcy nstrumnt s th ntrst rat, th montary polcy authorts hav vry grat nflunc n dtrmnng macroconomc qulbrum. In fact th montary polcy stratgy - of whch th MP curv s th rprsntaton - s abl to crat, onc gvn th dynamc supply curv and th IS curv, dffrnt lvls of ncom n accordanc to th nflaton targt, or dffrnt lvls of nflaton n accordanc to th ncom targt. Furthrmor - bcaus th natur and form of th MP curv dpnds both on constrants and targts th montary polcy consdrs and thy mght not b corrctly ntrprtd - th cntral bank could assum a msladng bhavour, gudng th conomc systm toward a lvl of actvty, not consstnt wth full mploymnt and prc stablty. JEL classfcaton: A20, E58, E61 Dpartmnto d Stud Economc -Unvrsty of Napls Parthnop Va Mdna Napls - Italy -mal: canal@unna.t; rorta.canal@unparthnop.t 1

3 EQUILIBRIUM INCOME AND MONETARY POLICY STRATEGY : TEACHING MACROECONOMICS WITH THE MP CURVE Abstract Th am of th papr s to prsnt a drvaton of a smpl tool dscrbng montary polcy bhavour, usful to tach macroconomc polcs n opn conoms, th MP curv. Th objctv s to ovrcom th lmts of th standard IS- LM modl and undrln th mportanc of th cntral bank stratgy n nfluncng output and mploymnt. W dmonstrat that f th man polcy nstrumnt s th ntrst rat, th montary polcy authorts hav vry grat nflunc n dtrmnng macroconomc qulbrum. In fact th montary polcy stratgy - of whch th MP curv s th rprsntaton - s abl to crat, onc gvn th dynamc supply curv and th IS curv, dffrnt lvls of ncom n accordanc to th nflaton targt, or dffrnt lvls of nflaton n accordanc to th ncom targt. Furthrmor - bcaus th natur and form of th MP curv dpnds both on constrants and targts th montary polcy consdrs and thy mght not b corrctly ntrprtd - th cntral bank could assum a msladng bhavour, gudng th conomc systm toward a lvl of actvty, not consstnt wth full mploymnt and prc stablty. JEL classfcaton: A20, E58, E61 1. Introducton Th most dffusd tool conomsts has bn usng to tach macroconomc polcy tll th nd of th XX cntury s th IS-LM modl bcaus dspt ts lmts - t has bn consdrd a vry powrful nstrumnt to undrstand th dmand sd. Howvr from th bgnnng of th 80s th powr to xplan through t mony markt workng and polcy stratgs has bn bcomng wakr and wakr. In fact conomsts movd som ntrnal crtqus 1 concludng that th IS-LM modl s unabl to captur th ral-world workng and th dynamc adjustmnts of supply and dmand. As Colandr (1995) says f supply and dmand ar ndpndnt th standard dsqulbrum analyss do not lad to a unqu qulbrum wth anythng lss than nstantanous prc lvl adjustmnt 2. Ths happns 1 Th xtrnal crtqus can b wdly r-conducd to th ncrasng rol of montary polcy and cntral banks n dtrmnng qulbrum ncom and to th thortcal rfus of fscal ntrvntons as actv polcy nstrumnts. 2 Colandr (1995) p

4 bcaus brfly summarzng what authortatv authors hav undrlnd - th IS-LM modl dos not nclud n ts analyss th nflaton rat and labour markt dynamcs (s for xampl Walsh 2002 and Bofngr t al Bofngr 2008). Furthr lmts hav rasd from th workng of modrn conoms n whch mony cannot b drctly controlld by montary polcy authorts, bcaus bankng and fnancal systms can crat or dstroy paymnt nstrumnts ach tm a cntral bank conducts a rstrctv or xpansv montary polcy rspctvly. Thrfor not n accordanc wth th mony markt qulbrum rprsntd by th LM curv - th cntral bank can control mony growth just ndrctly through th ntrst rat sttng (Kaldor Th pont s now accptd by all stram of thoughts). As Romr (2000 and 2005) wrts, th IS-LM modl s not consstnt wth modrn cntral banks practc of fxng th dscount rat. Morovr th ntrnatonal nlargmnt of countrs conomc dmnson maks vdnt that th ntroducton of th xtrnal balanc and of th xchang rat s not just a furthr complcaton of th modl but an ssntal lmnt that ought to b consdrd. Ths conclusons wr clarly ntroducd n th conomc rasonng at th bgnnng of th 90s wth th Taylor artcl ttld Dscrton vrsus polcy ruls n practc (1993). H found a practcal rul through whch th montary polcy, amng at controllng output and nflaton growth can b conductd. Th mony markt qulbrum was transformd through ths nstrumnt known as Taylor rul - n th on rsultng from th montary polcy stratgy. Mor rcntly th contrbutons of Davd Romr (2000) Kynsan macroconomcs wthout th LM curv appard on th Journal of Economc Prspctvs and Short-run fluctuatons (2005) xplctly ntroducd n common tachng a nw nstrumnt to b asly substtutd to th LM curv takng nto account th nw fndngs of montary polcy thory: th MP curv. Thn, th contrbutons of Walsh (2002) and Bofngr (th most rcnt s 2008, but s also Bofngr t al and 2006) trd to fll th gap corrlatd to th nflaton rat laboratng a modl ncludng prc dynamcs n opn conoms. 3

5 Th Romr s soluton howvr - has th vry mportant advantag that can b suprmposd to th old IS-LM modl wthout grat changs n th graphcal and analytcal tools, at last f w consdr th closd conomy or th flxbl xchang rats. It appars that t s not only abl to ovrcom th lmts of th standard modl, but has also thortcal mplcatons of th utmost mportanc: n fact t transforms th mony-markt qulbrum, onc rprsntd n th LM curv, nto on rsultng from th montary polcy stratgy. Th am of th papr s to prsnt a smpl analytcal drvaton of th MP curv, usful to tach macroconomcs n opn conoms and through whch undrln th mportanc of montary polcy n nfluncng output and mploymnt as th Taylor rul assrts - at last n th short run. W dmonstrat that f th man polcy nstrumnt s th ntrst rat, th montary polcy authorts hav, bcaus w nclud n th analyss nflaton and supply curv, vry grat nflunc n dtrmnng qulbrum ncom,. Th papr s organzd as follows: nxt paragraph prsnt a smpl analytcal drvaton of th montary polcy rul - th MP curv - n a closd conomy, takng nto account th ncom multplr dtrmnd constrant and th supply curv constrant. Paragraph thr xtnds th analyss to th opn conomy, dffrntatng th conclusons btwn flxbl xchang rats and fxd xchang rats. Th last paragraph summarzs th rasons why ths rprsntaton of th MP curv s abl to ovrcom th lmts of th modl ncludng th mplcatons of th polcy stratgs on th dfnton of th aggrgat qulbrum of nflaton and ncom. In fact th montary polcy stratgy of whch th MP curv s th rprsntaton s abl to crat, onc gvn th dynamc supply curv and th IS curv, dffrnt lvls of ncom n accordanc to th nflaton targt, or dffrnt lvls of nflaton n accordanc to th ncom targt. Furthrmor, bcaus th constrants mght not b corrctly ntrprtd, th cntral bank could assum a msladng bhavour, gudng th conomc systm toward a lvl of actvty, not consstnt wth full mploymnt and prc stablty. Ths mans that w cannot talk anymor about th mony th markt qulbrum dtrmnng th valus of nflaton and ncom at aggrgat lvl, but, at last n th short run, w hav to talk about 4

6 montary polcy qulbrum and ts nflunc on macroconomc condtons bcaus th natur and form of th MP curv dpnds both on constrants and targts th montary polcy consdrs. 2. Th MP curv n a closd conomy Wthout rcallng th LM curv, whos quatons ar wll known to whovr studs or tachs basc macroconomcs, w can start from th rlatons btwn supply and dmand n modrn montary markt. As usual th quaton rprsntng ral mony dmand s: (1) M = ( ky h) P Whr d M d s th nomnal dmand for mony and P th gnral lvl of prcs. Th ral dmand for mony s postvly rlatd to ncom Y followng th paramtr k and ngatvly rlatd to th ntrst rat followng th paramtr h. Accordng to currnt conclusons of conomc thory makng a smplfcaton of th argumnts brngng to th pont - mans of paymnt supply rsponds to th rqust comng from th markt. Thrfor w can say that mony supply dpnds on mony dmand so that: (2) M d = Ms = M Whr M s th quantty of mans of paymnt ndognously dtrmnd. From whch follows: (3) M = ( ky h) P Th sam rlaton can b xprssd usng logs - n trms of growth rat: (4) m = ky h+ π whr m s broad mony growth rat, π s th nflaton rat and k and h masur, as n prvous pag, th nflunc of ncom and ntrst rat on mony growth rspctvly. 5

7 W can assum, wthout gong too far from th truth, that a gnrc Cntral Bank wants to control th quantty of broad mony growth through th ntrst rat nstrumnt n ordr to rach ts objctvs whch ar output growth and/or th nflaton rat. W can assum also that, f th bankng systm crats too many mans of paymnt, th currncy looss ts valu. Th montary polcy authorty has thrfor a loss functon lnkd to th growth rat of mony: L = Lm ( ) Or, consdrng th varabls upon mony growth dpnds on: L = Lyπ (,, ) Wrtng th loss-functon n an xplct and vry smpl form w hav: L 1 = 2 ky + π h (5) ( ) 2 Th Cntral Bank looks for th rat of ntrst - th nstrumnt whch mnmzs th loss-functon or th m rat of growth. Mn L 1 = Mn ky + h 2 ( π ) 2 W can wthout bng mstakn suppos also that th cntral bank wants to control th mony growth takng nto account th lvl of th qulbrum aggrgat dmand of goods and th rlaton btwn nflaton and ncom on th sd of supply. W hav thrfor a constrand mnmzaton problm to solv. Th loss functon can b consdrd to b subjct to th followng constrants: (6) y = ρ( π ) sub π = σy + π Th frst quaton s a dynamc IS curv and rprsnt th multplr dtrmnd ncom quaton; ρ masurs th ffct of th ntrst rat and nflaton xpctatons varatons on th dmand dtrmnd qulbrum ncom. Th scond on s th supply curv whr currnt nflaton 6

8 s put nto rlaton wth ncom growth and nflaton xpctatons; σ rprsnt th slop of th supply curv. Suppos as frst stp that th cntral bank targts nflaton. W can rduc th constrant n on sngl quaton. Substtutng th IS n AS, w hav just on constrant: (6 ) π = σρ + (1 + σρ) π Consdrng - for th sak of smplcty - just on prod of tm, substtutng th constrant n th loss-functon and solvng for th rat of ntrst w hav: (7) + k σρ + h σρ + h 1 σρ t = π t + yt Th (7) s th racton functon of th cntral bank to ncom ncras and nflaton xpctatons ncras. Bcaus t drvs from a constrand mnmzaton procss t s also th optmal stratgy a cntral bank can us f t wants to rach a crtan nflaton. Indcatng wth: 1+σρ α = σρ + h ; and wth k β = σρ + h W can wrt: (8) = απ + βy t t or (9) = απt + βyt f π t = π.. f prcs xpctatons concd wth currnt valus. t Suppos now as a scond stp that th cntral bank targts also th ncom lvl. Thr s a quantty of mony growth m* consstnt wth th lvl of full mploymnt y * and targt nflaton π * and t s: m* = ky* h* + π * W can drv, followng th sam way of rasonng as bfor, th followng racton functon: 7

9 (10) * = απ * + βy* Whr * can b ntrprtd as qulbrum ntrst rat,.. th rat that allows to rach th lvl of full mploymnt and th targt nflaton 3. Subtractng quaton (10) from quaton (9) and solvng for th rat of ntrst w hav: (11) = * + α( π π*) + β( y y*) Whch s th quaton known as Taylor rul. Accordng to quaton (11) cntral bank fxs th ntrst rat takng nto account a knd of an qulbrum ntrst rat, th nflaton gap and th output gap. Prcsly th cntral bank ncrass ntrst rats abov * ach tm nflaton grows and ach tm ncom grows, but rducs t ach tm th nflaton gap ncrass and output gap ncrass too. W can rprsnt ths quaton through th so calld MP curv whch puts nto rlaton ntrst rat and output, othr thngs bng qual. (Fgur 1) As sad bfor t s th rsult of a constrand maxmzaton procss, and s thrfor a racton functon. Its slop dpnds on th valu of β whch n turn dpnds on mony dmand prfrncs k and h and on th slop of th supply curv σ and on th valu of th multplr ρ ; n partcular assumng 0 < ρ< f σ= α=1 β=0 ; σ= 0 1 α= h k β=. h In ths last cas th slop of th MP curv s qual to that of th old LM curv. Examnng n dpth th valu of th coffcnts w can say that th hghr th slop of th supply curv th lowr th ntrst rat racton on ncom ncras or dcras (panl b). Ths happns bcaus th qulbrum ncom dos not ncras as a consqunc of th dmand ncras and 3 Th grat part of authors consdrs ths valu of th rat of ntrst as qual to th ral captal rvnu,.. th rat of ntrst. 8

10 thrfor dos not prss on prcs 4. Th hghr s th slop of th supply curv th flattr s th MP curv. If w assum that σ has a valu of nfnt t mans that va sttng th ntrst rat th cntral bank dtrmns th valu of qulbrum aggrgat dmand just lookng at nflaton gap. Th lowr th slop of th supply curv, th gratr s th mportanc of mony dmand prfrncs n dfnng polcy stratgy as n th modl of th noclasscal synthss. Fgur 1. Th MP curv Each pont abov or blow th MP curv s not consstnt wth th optmal montary polcy stratgy: ach pont abov dscrbs a stuaton of xcss of rstrcton and ach pont blow dscrbs a stuaton of a too asy montary polcy n rspct wth targt nflaton and ncom (panl (a)). Th MP curv changs ts poston on th panl whn th valus of targt nflaton, or full mploymnt ncom, or qulbrum ntrst rat vary and prcsly: th hghr th targt nflaton th lowr th ntrst rat, th hghr th output gap th lowr th ntrst rat, othr thngs bng qual (panl (c)). 3. Th MP curv n an opn conomy Th sam way of rasonng can b xtndd to an opn conomy. Obvously w hav to dstngush btwn flxbl and fxd xchang rats. Lt s start from flxbl xchang rats bcaus t appars to b vry smlar to th cas of a closd conomy. Cas A: flxbl xchang rats Polcy authorty chos flxbl xchang rats to us montary nstrumnts to b fr to stablz nflaton and output, bcaus undr ths condton montary polcy can b managd autonomously. 4 Th sam consdratons can b don f w consdr th valu of ρ. In fact th lowr th valu of th multplr th lowr s th ffct on ncom of ntrst rat ncras and thrfor th lowr th racton ndd to prsrv th targt nflaton. 9

11 Th analytcal drvaton of th MP - th montary polcy rul n an opn conomy undr pur flxbl xchang rat rgm starts from th loss functon whch s th sam as n a closd conomy, bcaus th montary polcy authorty stll has th control on mony growth. Mor prcsly w hav agan: L 1 = ky + h 2 ( π ) 2 Othrws th constrant s : ( ) y = ρ π + ξe sub π = σy + π Bcaus now th IS curv s nfluncd by xchang rat movmnts. In fact ξ E s th ffct of th xchang rat on aggrgat dmand showng that undr th most dffusd crcumstancs an ncras of E (dprcaton) ncrass xports and dcrass mports, ncrasng thrfor th componnt of aggrgat dmand comng form abroad. Exprssng th constrant n on sngl quaton w hav: π = σρ+ (1 + σρ) π + σξ E Whch, f substtutd n th loss functon, gvs th quaton of th MP curv n an opn conomy undr flxbl xchang rat rgm: (12) 1+ σρ k σξ = π t + yt + E σρ + h σρ + h σρ + h Accordng to whch a dprcaton of th xchang rat rqurs an ncras of ntrst rats th cntral bank sts. Ths happns bcaus th currnt account surplus s a sourc of mony growth. σξ Or ndcatng wth γ = σρ + h (12 ) = βπ + δy + γe t t Whch bcoms as abov: (13) = * + α( π π*) + β( y y*) + γ( E E*) 10

12 Whr E * can b ntrprtd as th xchang rat allowng th balanc of paymnts qulbrum. E * s n fact th xchang rat that at th sam tm sts n qulbrum th currnt account and th ntrnal and xtrnal ntrst rats. If ( E E*) = 0th last trm of th racton functon can b omttd. Cas B: Opn conomy and fxd xchang rats Th montary polcy rul and th racton functon of th cntral bank changs f w consdr a fxd xchang rat rgm. Undr ths currncy rgm th Cntral bank cannot control anymor th domstc quantty of mony. It dpnds on th fact that montary polcy authorts hav as frst objctv th balanc of paymnt qulbrum undr th condton that th xchang rat s fxd. Th loss functon can thrfor b xprssd as dpndnt on assts and lablts of forgn xchang accounts: L= L( BP) Undr fxd xchang rats th balanc of paymnts surplus or dfct s qual to th varaton of offcal rsrvs: BP = RU Whch n turn s qual to: RU = x0yw + ξe my 0 + ω ( E E ) Bcaus th varaton of offcal rsrvs s a functon of all that dtrmns th balanc of paymnt,.. a postv functon of word ncom, xchang rat and of th dffrnc btwn ntrnal ntrst rat an forgn on and xpctd dvaluatons of th xchang rat, or th uncovrd ntrst party followng th paramtr ω whch masurs th dgr of captal moblty. Thrfor th loss functon can b wrttn also: 1 = RU 2 L 2 Or n an xplct form: 11

13 1 L = x Y + E my + ( E ) ξ ω 0 w 0 E 2 2 Dffrntly from prvous cass th constrant s gvn by th xchang rat fxd by polcy authorts: Sub E = E0 Substtutng th constrant n th loss functon and drvng for th nstrumnt th rat of ntrst, w hav th followng montary polcy rul undr fxd xchang rat rgms: ξ x0 m0 = E0 YW + Y + E + E ω ω ω Whch s lookng at t carfully prcsly th quaton of th balanc of paymnt, onc fxd th xchang rat. It says that th montary polcy authorty, f wants to rspct th xchang rats agrmnts and at th sam tm prsrv th balanc of paymnt qulbrum, has to ncras ntrst rats ach tm ntrnal ncom ncrass or forgn ncom rducs n ordr to compnsat wth captal nflows th currnt account dfct. In th sam way th cntral bank has to rs ntrst rats ach tm thr s an xpctd dprcaton of th xchang rat and an ncras of th forgn on. An ncras of th xchang rat rsultng from th agrmnts would caus a rducton of th ntrst rat. If thr s prfct captal moblty or ω = Th racton functon bcoms: = + E E And f th xchang rat s crdbl and oprators do not xpct dvaluatons or rvaluatons of th currncy E = 0 Th racton functon s totally dpndnt from abroad. = E 12

14 Accordng to whch t s not possbl to fx th ntrst rat at a valu not consstnt wth th balanc of paymnt qulbrum f w want to mantan th xchang rat agrmnts. Fgur 2 Th MP curv and BP curv undr dffrnt xchang rats rgms Fgur 2 shows th cas of th opn conomy: n scton (a) w hav th MP curv undr flxbl xchang rats whos slop and poston on th panl s st by th sam quatons as n a closd conomy, but w hav to add th shfts causd by th xchang rat movmnts. In partcular an ncras of E movs th curv upward and lftward, whl a dcras rghtward and downward. In th sam panl w hav rprsntd th BP curv n ordr to show th dffrnc wth th montary polcy stratgy. In scton (b) w rprsnt an MP curv undr fxd xchang ratd that could b lad ovr th ln rprsntng th balanc of paymnts and whos slop thrfor dpnds spcally o th captal moblty. So f ω = 0 th MP curv s vrtcal whl f ω= th MP curv s horzontal. 4. Th MP curv and th aggrgat dmand W sad that th Cntral Bank ntrst sttng procss n a closd conomy or undr flxbl xchang rat rgm follows a racton functon whch dpnds on ts loss functon and on th functons th IS and AS curvs follows or th montary polcy authorty thnk follows. In othr words th cntral bank follows a racton functon that rprsnt a montary polcy stratgy allowng to rach th targts, gvn th constrants. Bcaus th montary polcy stratgy curv (MP) as th LM s s th lackng curv to complt th dmand functon, w can say that th montary polcy authorty sts th dmand curv, gvn th constrants comng from th markt, or th cntral bank thnks com form th markt. Th graphcal rprsntaton can hlp us to undrstand th pont. (Fgur 3): Suppos th montary polcy authorty targts nflaton: onc gvn th IS (panl a) consstnt wth th xchang rat qual to that allowng th balanc of paymnts qulbrum ( BP = 0 bcaus 13

15 E = E *) and th AS (panl b) th cntral bank sts a racton functon (an MP curv) whch allows to dtrmn an AD curv crossng th supply curv (pont A) onc gvn th lvl of ncom Y 1 prcsly at that valu of nflaton π 1. Th sam way of rasonng can b appld f th Cntral Bank has an output targt. Fgur 3 Macroconomc qulbrum and montary polcy undr flxbl xchang rats Th fact that th cntral bank targts just nflaton or just output dpnds on ts stmat on th supply curv. Th montary polcy authorty follows a macroconomc modl n whch th supply curv can b consdrd to hav dffrnt slops or n whch th long-run valus f thy xst - ar consdrd to b much mor mportant than short run ons. Fgur 4. Macroconomc qulbrum and montary polcy: nflaton targtng and wrong stmat of th supply curv Problms ars whn th cntral bank has an stmat of th markt workng dffrnt from what t rally s, n partcular n rlaton to th supply curv. Suppos for xampl that th supply curv s horzontal whl th montary polcy authorty thnks t s vrtcal or, obsrvng facts from anothr pont of vw, obsrvs long-run valus and not short run ons (accordng to th cntral bank σ= so as th racton functon s = * + ( π π*) whl t s σ = 0 ). As fgur 4 shows, bcaus th supply curv of th Cntral Bank s AS bc whl th markt supply curv s AS m, th AD curv cratd by th montary polcy authorty dtrmns an nflaton hghr that th targt lvl π 1 > π 0 and a lvl of ncom lowr thn th qulbrum lvl y1 < y0. Nxt prod, bcaus obsrvd nflaton s agan hghr than th targt on, montary polcy ncrass agan ntrst rats, movng th MP curv upward n MP and th AD curv downward n AD, obvously causng a furthr rducton of qulbrum ncom. In ths cas f a cntral bank that targts just nflaton whn th supply curv has grat unmploymnt faturs, sts th conomc 14

16 systm n a condton of qulbrum of unmploymnt rmovng also any spontanous mchansm allowng to rach an hghr ncom lvl. Mutats mutands t can b sad also that a Cntral bank that just targts th output, consdrs th supply curv horzontal, whn t s not, lowrs too much ntrst rats causng xcssv nflaton that undrmns th conomc systm workng. Th stuaton s dpctd n fgur 5 whr as bfor AS bc s th Cntral bank supply curv, whl AS m s th ffctv on. Th montary polcy authorty lowrng ntrst rats from 0 to 1 movs aggrgat dmand rghtward from AD n AD n th attmpt to ncras output to y 1 > y 0 but rachng just th lvl of y 2. Bcaus th supply curv s upward orntd, output cannot ncras as dsrd, whl nflaton ncrass from π 0 to π 1. Addtonal movmnts can occur f w consdr th balanc of paymnts. In ths cas th procss of ntrst rat sttng has to tak nto account xtrnal rvnus. In fact th dffrnc btwn ths two valus causs xchang rat movmnts whch n turn caus also movmnts of th IS curv. But ths addtonal cass do not chang th natur of th phnomna. Fgur 5. Macroconomc qulbrum and montary polcy: output targtng and wrong stmat of th supply curv W can now consdr th cas of th MP curv of an opn conomy undr fxd xchang rats. It s a vry smpl cas bcaus th MP curv movs upward or downward only f th currnt polcy stratgy s not consstnt wth th balanc of paymnt qulbrum, gvn th xchang rat agrmnts. Ths mans that th lvl of aggrgat dmand dpnds ntrly on th balanc of paymnts qulbrum. Th supply curv can nflunc th aggrgat dmand through th ffcts nflaton has on th xpctd dprcaton or apprcaton of th xchang rat and thrfor on th balanc of paymnts. As fgur (6) shows f nflaton s hgh or s thought to b hgh and agnts sll natonal currncy n xchang for xtrnal on, th cntral bank has to ncras th ntrst rat to compnsat ths prssur movng th MP=BP n MP =BP and thrfor th aggrgat dmand. 15

17 Fgur 6. Montary polcy and qulbrum ncom undr fxd xchang rats rgm In ths cas th form and poston of th supply curv s not rlvant for th dfnton of th polcy stratgy, but t ntrs n dfnng prvat oprators nflaton xpctatons and thrfor natonal currncy valu xpctd varatons. Th slop of th supply curv dfns th output ffcts of a dmand movmnt and th long run sustanablty of th fxd party. In fact, for xampl a dcras of dmand, du to th ncras of ntrst rat ncssary to prsrv th balanc of paymnts qulbrum aftr an xpctd dprcaton - rducs th qulbrum ncom and affcts th gnral consnsus about th xchang rat agrmnts. 5. Conclusons Th montary polcy stratgy of whch th MP curv s th rprsntaton s abl to crat, onc gvn th supply curv dffrnt lvl of ncom n accordanc to th nflaton targt, or dffrnt lvl of nflaton n accordanc to th ncom targt. Th sam conclusons can b xtndd to an opn conomy n whch th ntracton of th balanc of paymnts ntroducs som addtonal varabls to b consdrd. In partcular undr flxbl xchang rats rgm, th MP curv vn rmanng as n a closd conomy movs also n accordanc wth th ffcts of ntrst rats movmnts on th qulbrum of th xtrnal accounts. Undr fxd xchang rats th MP curv xactly concds wth th balanc of paymnts curv bcaus no montary polcy s possbl othr than that consstnt wth th balanc of paymnt qulbrum. Ths chang n prspctv undrlns th rol of montary polcy n dfnng th macroconomc qulbrum and furnsh a usful tool to ovrcom th lmts of th old IS-LM modl. In fact, followng Colandr (1995), n ths rprsntaton supply and dmand ar consdrd rcprocally dpndnt. Th cntral bank dfns ts polcy stratgy n rlaton to th stmatd supply curv and thrfor crats an aggrgat dmand consstnt wth ts targts. 16

18 Followng Walsh (2002) and Bofngr (2008 and Bofngr t al and 2006), th IS-MP modl consdrs through th supply curv also th labour markt dynamcs. Fnally followng Romr contrbuton (2000 and 2005), ths t consdrs th cntral bank practc of sttng th ntrst rats nstad of th quantty of mony. Th addtonal concluson of th papr s that t s undrlnd th fact that th montary polcy stratgy dfnd by th MP curv s dply nfluncd by th vson of th conomc systm has. In turn ths vson f not concdnt wth th ral markt workng - dtrmns problms n th dfnton of aggrgat qulbrum ncom. Ths s tru both undr flxbl xchang rat n whch th polcy stratgy dtrmns th lvl of nflaton and unmploymnt, n rlaton to supply curv (actual or prsumd) and undr fxd xchang rats undr whch th polcy stratgy s dtrmnd xchang rats agrmnts. 17

19 Fgur 1. Th MP curv Panl (a) Panl (b) Too tght montary polcy MP Dffrnt slops y Too asy montary polcy Panl (c) MP Curv y Dffrnt postons y 18

20 Fgur 2. Th MP curv and BP curv undr dffrnt xchang rats rgms Panl (a) MP BP Panl (b) MP=BP Flxbl xchag rats y Fxd xchag rats y 19

21 Fgur 3 Macroconomc qulbrum and montary polcy undr flxbl xchang rats IS MP(Y 1, π 1 ) 1 BP Y 1 Y π AS AD π 1 A Y 1 Y 20

22 Fgur 4. Macroconomc qulbrum and montary polcy: nflaton targtng and wrong stmat of th supply curv 1 IS MP(Y 0 π 1 ) 0 MP(Y 0, π 0 ) Y 1 Y 0 Y π AS bc AD AD π 1 AS m π 0 A Y 1 Y 0 Y 21

23 Fgur 5. Macroconomc qulbrum and montary polcy: output targtng and wrong stmat of th supply curv 0 IS MP(Y 1 π 1 ) MP(Y 0, π 0 ) 1 Y 1 Y 0 Y π AS m AD AD π 1 AS bc π 0 Y 0 Y 2 Y 1 Y 22

24 Fgur 6. Montary polcy and qulbrum ncom undr fxd xchang rats rgm IS MP =BP MP=BP 2 1 Y 1 Y π AS AD AD π 1 π 2 A Y 2 Y 1 Y 23

25 Rfrncs Bofngr P. (2008) "Tachng Nw Kynsan Opn Economy Macroconomcs at th Intrmdat Lvl ", Th Journal of Economc Educaton, n prss. Bofngr P., Mayr E. and Wollmrshäusr T., (2006) "Th BMW Modl: A Nw Framwork for Tachng Montary Economcs", Th Journal of Economc Educaton, Vol. 37(1), pp , Bofngr P., Mayr E. Wollmrshäusr T. (2002) Th BMW modl: smpl macroconomcs for closd and opn conoms a rqum for th IS/LM-AS/AD and th Mundll-Flmng modl, Wurzburg Economc Paprs, n.35 Colandr D. (1995), Th Stors W Tll: A Rconsdraton of AS /AD Analyss, Journal of Economc Prspctvs- Vo. 9, n.3-pp Kaldor (1986), Th Scourg of Montarsm, Oxford Unvrsty Prss. Romr D. (2005), Short run fluctuatons, Unvrsty of Calforna, Brkly, Copyrght 2005 by Davd Romr Romr D. (2000) Kynsan Macroconomcs wthout th LM Curv, Journal of Economc Prspctvs Volum 14, Numbr 2 Sprng 2000 Pags Taylor J. B. (1993), 'Dscrton vrsus polcy ruls n practc'. Carng-Rochstr Confrnc Srs on Publc Polcy 39, pp Walsh (2002) Tachng Inflaton Targtng: An Analyss for Intrmdat Macro, Journal of Economc Educaton, Fall. 24