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Macroeconomics. Short Run Open Economy Macroeconomics. Standards of Macroeconomics by N. Gregory Mankiw Extensive Open Economy IS-LM Model. Teacher: Prof. John M. Veitch. Financing cost Differentials. Expected for little open economy that r = r * … yet not generally genuine on the grounds that:
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Macroeconomics Short Run Open Economy Macroeconomics

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Principles of Macroeconomics by N. Gregory Mankiw Large Open Economy IS-LM Model Instructor: Prof. John M. Veitch

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Interest Rate Differentials Assumed for little open economy that r = r * …but not generally genuine in light of the fact that: Country Risk drives speculators to request danger premium. Expected Changes in EXR lead financial specialists to request premium (or markdown) to make up for change. Accept r = r * + q, where q = Country premium decided exogenously by financial specialist discernments. Little Open Economy IS-LM Model given by: (IS) Y = C(Y-T) + I(r * + q ) + G + NX(e) (LM) M/P = L(r * + q , Y)

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1. Increment in Country Risk - expands hazard premium . LM * 2 - higher residential interest rate. 2. I falls, movements IS Curve internal. 2. 3. 3. Cash Demand diminishes. - shifts LM Curve outwards . 4. Results: - EXR deteriorates. - Real GDP rises. 4. e 2 IS * 2 Y 2 Increase in the Risk Premium LM * 1 Exchange Rate e 1 IS * 1 Y 1 Income, Output

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Int’l IS-LM and AD Curve Look at Price Changes in Open Economy IS-LM. Review NX relies on upon e = e(P/P * ), so IS-LM is: (IS) Y = C(Y-T) + I(r * ) + G + NX( e ) (LM) M/P = L(r * , Y) Assume Domestic Price Level ascents; Real Money supply falls, shifts LM inwards. Genuine conversion scale rises, NX falls, lower Real GDP. This is the AD Curve for little open economy. Whatever other variables that move IS or LM will move AD Curve correspondingly.

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LM * (M/P 2 ) e 2 3. 2. Y 2 4. P 2 1. AD(G,T,M,r * ) Y 2 Open Economy AD Curve e LM * (M/P 1 ) Begin at Price Level P 1 with IS 1 and LM * 1 . 1. Expansion Price level to P 2 . - LM * movements to LM * 2 . 2. Expansions conversion standard, e 2 . 3. Lower level of genuine GDP, Y 2 , at higher Price level P 2 . 4. Notice Curve outlines relationship of P and Y. Anything that moves IS or LM Curve (with Price level settled) will move AD Curve. e 1 IS 1 Y Price Y 1 Level P 1 Y 1 Y

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2. Y SR < Y LR so Unemployed assets lead to fall in data costs. 3. SRAS movements down, Price level falls, LM * movements out as M/P increments. 4. New LR harmony at Y LR , lower Price level P 2 and swapping scale, e 2 . LM * 2 3. 2. P 2 4. e 2 SRAS 2 4. Y LR IS-LM & AD Curve in SR & LR 1. Start beneath LR harmony at point 1 as consequence of stun to economy. LRAS LM * 1 AD * e P SRAS 1 P 1 e SR 1. 1. IS * Y SR Y LR Y SR Y

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Principles of Macroeconomics by N. Gregory Mankiw Chapter 11 Appendix: Large Open Economy in the Short Run Instructor: Prof. John M. Veitch

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Large Open Economy Solution Large open economy sets own advantage rate. IS-LM Model with Price Levels settled (IS) Y = C(Y-T) + I(r) + G + NX(e) (LM) M/P = L(r,Y) Solve for harmony levels of r 1 and Y 1 . Net Foreign Investment Solve for NFI(r 1 ) at Domestic genuine premium rate. Market for Foreign Exchange Take NFI(r 1 ) as “Supply” of residential cash. Draw NX(e) as “Demand” for household cash. Discover swapping scale, e 0 , where NFI(r 0 ) = NX(e 0 ).

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Large Open Economy IS-LM Combine 3 comparisons of Large Open Economy into 2 mathematical statements for IS-LM. Altered IS-LM Model substitute Currency Mkt Equilib. (NX = NFI) into IS . (IS * ) Y = C(Y-T) + I(r) + G + NFI(r) (LM) M/P = L(r,Y) Solve for harmony levels of r 1 and Y 1 . Including NFI(r) makes Large Open Economy IS Curve compliment than Closed Economy IS Curve. Compliment is NFI(r) Curve, compliment is the IS* Curve.

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IS-LM for Large Open Economy Real LM Interest Rate r 1 IS * Y 1 Income, Output

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Net Foreign Investment Real Interest Rate NFI 0 NFI negative NFI positive

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Market for Foreign Exchange Market for outside coin trade. “Supply” of Dollars : Net Foreign Investment, NFI(r 1 ). “Demand” for Dollars : Net Exports, NX(e). Higher genuine conversion standard lessens Net Exports. Harmony : NFI(r 1 ) = NX(e) decides the genuine swapping scale and the amount of dollars traded for remote cash. NFI controlled by IS-LM outline however decides “ Supply ” in Market for Foreign Exchange.

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Market for Foreign Exchange NFI(r 1 ) Exchange Rate (Supply of $) e 1 NX(e) (Demand for $) $ 1 # of $ Exchanged

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r 1 Y 1 NFI(r 1 ) e 1 Net Foreign Investment r LM r NFI IS * Income, Ouput NFI IS-LM Diagram Exchange Rate NX(e) Large Open Economy # of $ Market for Foreign Exchange

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Fiscal Policy Effects of Expansionary Fiscal Policy in Large Open Economy. Increment in Gov’t Purchases movements IS * outwards. Results: Output and Real Interest Rate Increase. Brings down Domestic Investment and NFI. Fall in NFI lessens Supply of Foreign Exchange. Genuine Exchange Rate Appreciates. Gov’t monetary approaches along these lines influence yield, residential genuine premium rate, venture, and conversion scale.

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r 2. IS * 2 1. D G Y 2 NFI 2 3. e 2 4. Net Foreign Investment r LM r 1 NFI IS * 1 Y 1 Y NFI IS-LM Diagram NFI 1 Exchange Rate NX Fiscal Policy: Increase in G e 1 # of $ Market for Foreign Exchange

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Monetary Policy Effects of Expansionary Monetary arrangement in a Large Open Economy. Increment in Nominal M s shifts LM Curve outwards. Results: Real Interest Rate falls, Output and NFI increment. Increment in NFI builds Supply of Foreign Currency Exchange rate devalues, Net Exports increment. Money related arrangement influences Output, residential genuine premium rate, NFI, Net Exports, and conversion standard.

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LM 2 1. D M 2. r 2 Y 2 NFI 2 3. 4. e 2 Net Foreign Investment r LM 1 r 1 NFI IS * Y 1 NFI IS-LM Diagram NFI 1 Exchange Rate NX Monetary Policy: e 1 Increase M S # of $ Market for Fo

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