Macro - Open economy AD/AS

Why is AD downwards sloping

if P rises → real M^s falls → LM shifts inwards → move along IS → i rises → I & Y fall

opposite if p falls

Movements along AD in open economy

Changes in p can have 2 effects:

• Real M^s : P rise → M/P fall → i rise → Z & Y fall

• Real ER (ε) : P rise → E * P/ p* rise → NX fall → Z & Y fall

  • RER appreciates → M up & X down

P change now shifts the IS curve as well

For fixed ER, adjustment to MR can only occur from changes to ε

AD slope in closed vs open float vs open fixed

IS moves as well in open economy

Increase of P effect on AD open economy

Increase in P → ε appreciation → Y falls → IS shifts in

T & E increase OR G decrease = AD shifts inwards

what expectations are there in this model

P^e are fixed in SR

Adaptive expectations

In SR we can move away from Y_n (business cycles)

FP under Fixed ER - SR explanation

FP under Fixed ER - MR explanation

FP under Fixed ER - AD/AS Graph

FP under Fixed ER - all graphs SR

FP under Fixed ER - all graphs MR

FP under floating ER - explanation SR

FP under floating ER - explanation MR

FP under Fixed ER - AD-AS graph

FP under Fixed ER - all graphs SR

FP under Fixed ER - all graphs MR

FP under fixed ER with devaluation - graph

Devaluation

Devaluing the currency is tempting after a negative AD shock

Devaluing → E & ε fall → NX up → Y up → AD up

with a perfect devaluation (to where he currency should be), AD shifts back to exactly as it was pre shock

Cons of devaluation

• Hard to find perfect devaluation

• Initial effect of devaluation may be contractionary - J curve

• Devaluation not possible in a Monetary union

• Price of imports rise → consumers worse off as p rises

• Workers might ask for higher nom w → firms increase p

  • CB might try to defend one ER when investors think its different

SS under fixed ER - SR explanation

AS SHIFT ONLY

SS under fixed ER - MR explanation

AS SHIFT ONLY

SS under fixed ER - AD-AS graph

SS under fixed ER - all graphs SR

SS under fixed ER - all graphs MR

SS under floating ER - SR explanation

SS under floating ER - MR explanation

SS under floating ER - all graphs SR

SS under floating ER - all graphs MR

SS under floating ER - AD-AS graph