Open economy' An ISLM model

1
Open economy. An IS/LM model

• Objectives
• Re-examine impact of fiscal and monetary policy
  in open extension of IS/LM under both fully
  flexible and fixed exchange regimes
• Reading
• Blanchard, chapter 20

2
Equilibrium in the goods market
3
Equilibrium in financial markets
4
Arbitrage

• Assume iUS0.05, iJAPAN0.05, E100, Ee100
• What happens if iUSincreases to 0.08?

5
Arbitrage
6
IS/LM
7
IS/LM
8
Expansionary Fiscal Policy
9
Contractionary Monetary Policy
10
Twin deficits. The US in the 1980s
11
Twin deficits
12
Exchange-rate regimes

• Flexible exchange-rates (e.g., US, Japan)
• Fixed E-Rate Regimes
• Crawling Pegs
• European Monetary System
• Euro

13
Monetary policy under a fixed exchange-rate

• Assume an exogenous increase in money demand
• CB buys bonds
• CB buys foreign currency
• What are implications?
• Loss of monetary policy
• Domestic and foreign interest-rates are equal

14
Fiscal Policy Under Fixed Exchange-Rates