Macroeconomics and the Monetary System

1. Macroeconomics and the Monetary System Homework Problem: The Complete Model with Flexible Exchange Rates

2. Expansionary Monetary Policy in Venezuela: Flexible Exchanges Rates, High Capital Mobility SHOCK: Expansionary Monetary Policy in Venezuela 2 Capital Account Effect 3 Current Account Effect 1 Monetary Expansion Foreign Exchange Market Money Market Goods Market 4 5 Ricciardi

3. Expansionary Monetary Policy in Venezuela: Flexible Exchanges Rates, High Capital Mobility SHOCK: Expansionary Monetary Policy in Venezuela Money Market Ricciardi

4. r Ms Ms ' r1 r2 Md(Y1) M/P Expansionary Monetary Policy in Venezuela: Flexible Exchanges Rates, High Capital Mobility SHOCK: Expansionary Monetary Policy in Venezuela • Central Bank: • Open Market Purchase • Decrease Discount Rate • Lower Required Reserve Ratio • Ms > Md • Invest Excess Money Balances • Buy Bonds, Increase Pb • Lower Interest Yields • Lower Interest Rates • Induce Capital Outflows • Increase Real Investment and Consumption Money Market Ricciardi

5. Foreign Exchange Market Money Market Goods Market 1 Monetary Expansion r Ms Ms ' r1 r2 Md(Y1) M/P SHOCK: Expansionary Monetary Policy in Venezuela 2 Capital Account Effect Ricciardi

6. 1 Monetary Expansion => AD => Y, P Foreign Exchange Market Money Market Goods Market P r Ms Ms ' AS r1 r2 AD Md(Y1) M/P Y Y1 Y2 • Increased Real Investment • AD > AS • Upward Pressure on Prices & Output • Relative Effects a ƒ of location on AS • Increased Y& P Deteriorates CAcct SHOCK: Expansionary Monetary Policy in Venezuela Ricciardi

7. Foreign Exchange Market Money Market Goods Market P r Ms Ms ' AS r1 r2 AD Md(Y1) M/P Y Y1 Y2 3 Capital Account Effect SHOCK: Expansionary Monetary Policy in Venezuela 2 Current Account Effect 1 Monetary Expansion Ricciardi

8. K Accnt: (-) ≠ D for $ Ø r => ≠ S of Bs ØNE => ≠ S of Bs, ≠D for $ C Accnt: (-) ≠ Y, ≠ P => Foreign Exchange Market Money Market Goods Market $ / Bs S S ' 1 2 D SHOCK:Expansionary Monetary Policy in Venezuela 1 Monetary Expansion Depreciation of Bs Bs / t Ricciardi

9. K Accnt: (-) ≠ D for $ Ø r => ≠ S of Bs ØNE => ≠ S of Bs, ≠D for $ C Accnt: (-) ≠ Y, ≠ P => $ / Bs S S ' 1 2 D SHOCK:Expansionary Monetary Policy in Venezuela • Capital Outflow means flight from Bs to foreign exchange • Rising Y induces imports, dumping Bs, demand for Fx • Rising domestic P induces additional imports • Both the Current and Capital Account Effects of Monetary Policy changes are self-reinforcing • Expansionary Monetary policy produces a depreciation of the domestic currency • Falling NE reduce AD, but depreciating Bs increases NE, increasing AD Foreign Exchange Market Depreciation of Bs Bs / t Ricciardi

10. ≠ Ms => ≠ AD => ≠ Y, ≠ P K Accnt: (-) ≠ D for $ Ø r => ≠ S of Bs ØNE => ≠ S of Bs, ≠D for $ C Accnt: (-) ≠ Y, ≠ P => r P $ / Bs S S ' 1 2 D M/P Y Bs / t 3 2 5 1 4 Shock: Central Bank of Venezuela conducts expansionary monetary policy Money Market Goods Market Foreign Exchange Market Ms Ms ' AS r1 r2 Depreciation of Bs Md(Y2) AD Md(Y1) Y1 Y2 ≠ Y => ≠ Md, choking off Ø r Depreciation of Bs => ≠ NE Ricciardi