Mon Base = curr + bank res, MS = curr + depositis. MS = mm x mon base. Ppl hold cash – cu inc and mm decl. dec in MS. To give cust cash, bank must xch res at fed for curr, base same but more curr and less res. Inc in r hold less curr MS rises b/c public cash-ratio cu dec. mm rise and so will MS. MB unchanged. Bank obtain discount loan from fed inc reserves. MB and MS rise. No other effect. Inc uncertainty about dep w/drawl bank holds less res. Mm falls b/c xr, reserve-holding ratio inc, mm lower bc of dec in lending vol and fewer deposits, MS dec. fed buys lots of l/t treasure bonds for QE inc res and MB. MS inc. mm is unchanged. Fed sells bonds MB drops as bank res fall. ...view middle of the document...
Explain effect of inc in c. if fed targets MS, what happens to GDP and r? inc in C shifts IS right. Fed target MS, Ms/P constant, GDP inc. this inc MD and excess d for $ inc r to pt 1 on IS1 Fed targets r, what would they do? Higher d for $ will cause r to rise. (IS shift right) Fed sees fed funds rate rising. Sign of Excess d for $. To reduce r back, fed buy bonds inc MS, shifting LM right. Inc GDP more and r stays at original level. Why targeting r bad idea? By Keeping r from rising, AD and GDP will rise too much, economy overheats, infl will result. If infl does pick up, nominal r will rise even if real r is constant. If fed targets nominal r, will inc MS even more causing more infl. Decline in c and I, compare what happens if target MS or r and illustrate. Shifts IS left. If Fed targets MS, Ms/P and LM don’t change. GDP falls to Y1 and r fall to r1 b/c dec in GDP reduced MD and causes ESof$. Decl in r keeps d for goods from falling. However, if Fed targets r at r0, fed see the fed funds rate fall so fed would sell bonds, reduce MS, shift LM left, so r return to r0. This reduces GDP even more to Y2 making recession worse. Given this how can Keynesian economist defend targeting r? say it makes sense to b/c r affects c and I. targeting MS may not be useful if MD is not stable. Fed target r, but change the target r depending on economic conditions such as GDP growth, infl, and unempl. If economy grow to fast/overheat, can raise r. in recession or rising unempl, can lower r. this is what taylor rule suggests.
Graph – ER on y, For Exch on x. Typical supply/dem&. D=imports & cap outflows & S=exports & capital inflows
a)effect on current or capital account b)For Ex graph -illustrate effect on supply or dem& for for ex c)if central bank wants to maintain original ER (fixed or dirty float), what need to do? d)if central bank allows ER to float, what happens? 1. Domestic Interest Rate decrease. dec cap inflows & inc cap outflows as for assets look more profitable than domestic assets Capital acct moves into deficit. Reduces S of for exch (S shift left) & inc D (D shift right), creates excess dem& for for curr. fixed – to hold to ER0 mon authorities intervene, selling the for curr & buying domestic curr. Flexible exchange rate – curr depreciates to ER1 (above ER0) 2. Economy goes into recession causing imports to fall. income declines so purchase fewer imports. Causes the current acct to improve or move into surplus. Dem& for for curr declines (D shift left) = excess supply of for curr. fixed – central bank must intervene buy for curr & sell home curr. flexible – home curr would appreciate to ER1(below ER0)
3. Productivity increases raise competitiveness & exports rise. will increase export sales & earnings. Moves current acct into surplus. Increases supply of for exch. With fixed ER – mon authorities intervene & buy for exch & sell domestic curr. If flexible,...