Themes. Flexible exchange rates with inflation targeting. Expectations formation under flexible exchange rates

Transcription

1 CHAPTER 25 THE OPEN ECONOMY WITH FLEXIBLE EXCHANGE RATES Thms Flxibl xchang ras wih inlaion arging Expcaions ormaion undr lxibl xchang ras Th AS-AD modl wih lxibl xchang ras Macroconomic adjusmn undr lxibl xchang ras Th xchang ra: shock absorbr or a sourc o shocks? Exchang ra ovrshooing FLEXIBLE EXCHANGE RATES WITH INFLATION TARGETING Uncovrd inrs pariy: i= i +, ln E, ln E () Equaion () implis ha h cnral bank can rly s h domsic inrs ra i indpndnly o h orign inrs ra, providd i is willing o accp h rsuling ndognous adjusmn o h xchang ra. Undr lxibl xchang ras h xchang ra canno srv as a nominal anchor. Mos dvlopd counris wih loaing xchang ras hav hror chosn o announc an oicial arg inlaion ra and o dlga monary policy o an indpndn cnral bank o nhanc h crdibiliy o h inlaion arg.

2 MONETARY POLICY UNDER INFLATION TARGETING Fr loaing wih sric inlaion arging: * i= r h, h> 0 (2) Fr loaing wih lxibl inlaion arging (Taylor-rul): * i= r + + h + b y y, h> 0, b> 0 + Diry loaing wih sric inlaion arging: * i= r +, 0, 0 + h + λ h> λ > + In his chapr w assum or simpliciy ha b=λ=0, bu all our qualiaiv rsuls also hold whn b and λ ar grar han zro. THE INFLATION TARGET In long run quilibrium rlaiv purchasing powr pariy will hold: = = r r I h cnral bank wishs o avoid a sysmaic apprciaion or dprciaion in h long run, i mus kp h domsic inlaion ra in lin wih h orign inlaion ra. W hror asssum ha (3) = * In pracic mos dvlopd counris wih loaing xchang ras hav acually chosn an inlaion arg o 2-2½ prcn, as shown in abl 25..

3 INFLATION EXPECTATIONS I h inlaion arg is crdibl, i sms rasonabl o assum ha = = + = * (5) Th assumpion in (5) is analogous o h assumpion in Chapr 24 ha h cnral bank s commimn o a ixd xchang ra (which rquirs = in h long run) was crdibl. EXCHANGE RATE EXPECTATIONS Rgrssiv xchang ra xpcaions : ( θ ) + = θ + = θ +, θ > 0 (6) h xpcd normal xchang ra, which mus b assumd o dpnd on h obsrvd hisorical xchang ras. W hror mak h simpliying assumpion ha: = (7) Insring (7) ino (6), w g

4 EXCHANGE RATE EXPECTATIONS = θ (8) + Rcall ha i i + = + () Subsiuion o (8) ino () yilds = θ i i (9) ( ) Thus h domsic currncy will apprcia (dprcia), whn h domsic inrs ra is highr (lowr) han h orign inrs ra. THE EXCHANGE RATE, RISK AND INTEREST Ralisically, h condiion or uncovrd inrs pariy mus b modiid o i= i ρ (a) whr h risk prmium ρ (which could b ngaiv) may b spciid as [ ] ρ= v+ ε, E ε = 0 Subsiuion o (8) and (rho) ino (a) givs ( / ) ( / )( ) ( / ) (rho) = v θ θ i i + θ ε (0) Empirical analysis suppors h hypohsis ha h coicin /θ is signiicanly posiiv, as indicad in Figur 25.

5 DERIVING THE AD-CURVE UNDER FLEXIBLE EXCHANGE RATES According o Chapr 23, h gnral condiion or goods mark quilibrium is r ( ) ( + + ) y y = β + + β i + r + z, 2 (2) ( ln ln ) z β g g + β y y + β ε ε From () and (9) w rcall ha W also know ha + = i i () = θ i i (9) DERIVING THE AD-CURVE UNDER FLEXIBLE EXCHANGE RATES i = i = r (URR) + Insring (), (9) and (URR) in (2), w g ( r ( ) ) ( ) y y= β θ i i + β i i + r r + z (3) 2 Thus domsic monary policy acs aggrga dmand via h xchang ra channl θ - (i-i ) and via h inrs ra channl i-i. Sinc + = h monary policy rul (2) may b wrin as i r h = + + i i h = (4)

6 THE AGGREGATE DEMAND CURVE Insring (4) ino (3), w obain h AD-curv undr lxibl xchang ras r y y = β ˆ β + z, ˆ β β + h ( β2 + θ β), ( ln ln ) z β r r + β g g + β y y + β ε ε (5) For comparison, rom Chapr 24 w hav h AD-curv undr ixd xchang ras y y= β β + z r ( ) + (6) EXCHANGE RATE DYNAMICS W prviously ound ha = i i θ i i = h Subsiuion o (4) ino (9) givs h (9) (4) Nominal xchang ra dynamics = hθ (8) r r Sinc = + + w may us (8) o driv h Ral xchang ra dynamics = + + hθ (9) r r

7 SUMMARIZING THE AS-AD MODEL OF THE OPEN ECONOMY WITH FLEXIBLE EXCHANGE RATES AD-curv (rarranging (5)): β y y z r = + ˆ β ˆ β (20) SRAS-curv (rlaiv wag rsisanc): = + γ y y + s (2) Ral xchang ra dynamics (rarranging (9)): = + + hθ (22) r r THE ADJUSTMENT TO LONG-RUN EQUILIBRIUM UNDER FLEXIBLE EXCHANGE RATES y

8 THE SPEED OF ADJUSTMENT Flxibl xchang ras (or z=s=0): y y y y a a + γhβ 2 = o, + h ( h ) γ β γβ θ Fixd xchang ras (or z=s=0): y y= ( yo y) β, β + γβ (3) (30) β Dirnc in spd o adjusmn a = ( ) γ h β θ γ β 2 ( + γ βˆ )( + γ β ) (32) SHORT-RUN EFFECTS OF A NEGATIVE SUPPLY SHOCK UNDER FIXED VERSUS FLEXIBLE EXCHANGE RATES y

9 SHORT RUN EFFECTS OF A DEMAND SHOCK Flxibl xchang ras (soluion o (20) og (2)): y y = z + γ β + γ h β + θ β 2 (33) = γ z + γ β + γ h β + θ β 2 (34) y Fixd xchang ras: y = z + γ β (35) = γ z + γ β (36) SHORT-RUN EFFECTS OF SHOCKS UNDER FLEXIBLE EXCHANGE RATES COMPARED TO EFFECTS UNDER FIXED EXCHANGE RATES Typ o shock Shor-run lucuaions in Dmand shock Supply shock Oupu Smallr Largr Inlaion Smallr Smallr

10 IS THE EXCHANGE RATE A SHOCK ABSORBER OR A SOURCE OF SHOCKS? From (0) w rcall ha ( / ) ( / )( ) ( / ) = v θ + θ i i + θ ε Criics o loaing xchang ras argu ha h lucuaions in h risk prmium ε ar so gra ha a loaing xchang ra is an indpndn sourc o insabiliy rahr han an absorbr o shocks. A irs glanc h mpirical obsrvaions in Figur 25.4 suggs ha grar xchang ra variabiliy is in ac associad wih lss insabiliy o oupu, bu his corrlaion disappars i w rmov h w xrm oulirs in h daa. Th daa in Tabl 25.3 also suggs ha h xchang ra is only drivn o a small xn by hos shocks ha nd o driv h movmns in oupu, indicaing ha xchang ra lxibiliy only srvs o a small xn o absorb shocks o oupu. PROPORTION OF THE VARIANCE OF OUTPUT, INFLATION AND NOMINAL EXCHANGE RATE EXPLAINED BY VARIOUS TYPES OF SHOCKS, Prcn o varianc xplaind by Counry Varianc o Supply shocks Ral dmand shocks Forign and domsic monary policy shocks Exchang ra shocks Oupu Canada Inlaion Exchang ra Oupu Dnmark Inlaion Exchang ra Oupu Swdn Inlaion Exchang ra Oupu Unid Kingdom Inlaion Exchang ra

11 EXCHANGE RATE OVERSHOOTING Exprinc shows ha loaing xchang ras lucua a lo in h mdium run and may mov vry ar away rom hir (simad) long run quilibrium valus. This migh suggs irraional bhaviour in h orign xchang mark, bu in ac i could b consisn wih raional xchang ra xpcaions. W shall now s how. From (), (5) and (6) w rmmbr ha i = i + + () + = = = * (5) + = θ (6) OVERSHOOTING Subracing on boh sids o () and insring (6), w g r = r + θ (38) Suppos now ha h domsic govrnmn prmannly rlaxs is iscal policy. According o Figur 25.6 his will caus a long-run apprciaion o h ral xchang ra which will parly occur hrough an apprciaion o h nominal xchang ra, ha is, hrough a all in h valu o. In h shor run h iscal xpansion will gnra highr inlaion, inducing h cnral bank o rais r. I agns in h orign xchang mark anicipa ha has alln, i ollows rom (38) ha h currn xchang ra has o all by morhan whn r gos up. Hnc h xchang ra will 'ov rshoo' in h shor run.

12 LONG RUN EFFECT OF A FISCAL EXPANSION