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Lecture 10: The Goods Market and the Exchange Rate

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

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Lecture 10: The Goods Market and the Exchange Rate

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  1. Lecture 10: The Goods Market and the Exchange Rate • Devaluations (static and dynamic responses) • Exchange rate determination (capital markets) • The open economy IS-LM

  2. The Goods Market Z = C + I + G + X - e Q C(Y-T) + I(Y,I) + G Q = Q(Y,e) + - X = X(Y*,e) + +

  3. Figures • Figs 19-4, 19-5 • Increase in foreign demand • games countries play • depreciation

  4. 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

  5. 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) i(t) = i*(t) + E(t+1) - E(t) E(t) e

  6. Cont. The Exchange Rate i i* e E E e i = i* + E - E E given E and i* e

  7. The Open Economy IS-LM Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*,E) M = Y L(i) P E = E 1+i-i* e e IS : Y = C(Y-T) + I(Y,i) + G + NX(Y,Y*, E / (1+i-i*))

  8. Interest parity i LM IS E Y 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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