FIXED EXCHANGE RATE: Fixed ER w/ No Capital Mobility (1: At SR w/ full employmen

Question

FIXED EXCHANGE RATE:

Fixed ER w/ No Capital Mobility (1: At SR w/ full employment, 2: At SR w/ unemployment)

Fixed ER: Central Bank (CB) buys and sells foreign assets to keep ER fixed relative to other currencies.

No Capital Mobility: Domestic residents do not trade in financial assets with the rest of the world because of a lack of access or integration to international capital markets.(Instead CB holds reserves in form of foreign assets..aka currencies in order to maintain fixed ER.)(Domestic residents cannot borrow from or lend to foreign residents at any interest rate, so the capital account is perfectly inelastic(unresponsive) with respect to interest rate.

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Fixed ER w/ Perfect Capital Mobility (1: At SR w/ full employment, 2: w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Fixed ER w/ Relative Capital Mobility (1: At SR w/ full employment, 2: w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Fixed ER w/ Relative Capital Immobility (1: At SR w/ full employment, 2: w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

FLEXIBLE EXCHANGE RATE

Flexible ER w/ No Capital Mobility (1: At SR w/ full employment, 2: At SR w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Flexible ER w/ Perfect Capital Mobility - (1: At SR w/ full employment, 2: At SR w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

Short-Run Results -

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Flexible ER w/ Relative Capital Mobility (1: At SR w/ full employment, 2: At SR w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Flexible ER w/ Relative Capital Immobility (1: At SR w/ full employment, 2: At SR w/ unemployment)

Fiscal(G, T):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Monetary(Ms):

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Exchange Rate Mgmt:

Immediate-Run Process -

1)

2)

Short-Run Results -

1)

2)

Can you please explain the process using different policies under each exchange rates system? You dont need to finish all of them but just some parts, I would be very grateful! It's due on tommorrow noon, thanks!!!

Explanation / Answer

Fixed exchange-rate with no capital mobility:

1) Immediate-Run process and short-run results of fiscal expansion:

An expansionary fiscal policy will move IS curve to right. The new intersection of IS-LM curve shows the increased interest rate and causes balance of payment surplus which will cause domestic currency appreciate. Under a fixed exchange rate, government will intervene in foreign exchange market by buying foreign currency and sell domestic currency in order to prevent currency appreciation. The intervention will cause LM curve move to right.

2) Immediate-Run process and short-run results of monetary expansion:

Monetary expansion will lead to pressure on exchange rate to depreciate. To maintain the fixed exchange rate level, the money supply must return to the initial position.

Fixed exchange-rate with perfect capital mobility:

1) Immediate-Run process and short-run results of fiscal expansion:

Under fixed exchange rate, expansionary fiscal policy shifts IS curve to right and the payment balance is surplus. In order to defend fixed exchange rate, central bank will sell domestic currency in foreign exchange market, which will cause LM curve move to right, and the economy shifts toward a new full equilibrium point. Domestic production increased and fiscal policy is strong

2) Immediate-Run process and short-run results of monetary expansion:

Expansionary monetary policy, fixed exchange rates

LM shifts right, Y increases and R decreases.

Lower R decreases foreign capital outflows.

Creates deficit in balance of payment and creates downward pressure on currency.

Central bank intervenes in the foreign exchange market by selling foreign exchange reserves by buying excess domestic currency. It decreases the domestic money supply.

LM curve shifts left, Y decreases and R increases to its original level.

Result is same Y and R.

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